MORAL HAZARD AND SECURED LENDING IN AN INFINITELY REPEATED CREDIT MARKET GAME

We analyze repeated moral hazard with discounting in a competitive cre dit market with risk neutrality. Even without learning or risk aversio n, long-term back-borrower relationships are welfare enhancing. The ma in result is that the borrower obtains an infinite sequence of unsecur ed loans at below spot market cost following the first good project re alization. This contract produces first-best action choices. Prior to this stage, the borrower gets secured loans with above-market borrowin g cost. The optimal contract thus displays a ''selective memory'' feat ure, taking only one of two forms at any given point in time, dependin g on prior history.