The Abrahamic religions take a radical view of debt. Charging excess interest is the sin of usury, and outstanding obligations are supposed to be periodically canceled during jubilee years. The old moralists understood the dangers of insisting on the repayment of unpayable debts. But the global financial crisis has revealed that we badly need to relearn this wisdom.
A debt crisis occurs when the credit that has sustained spending suddenly dries up, making it difficult or impossible for debtors to service their debts. This is what happened to both U.S. investment banks and eurozone governments from 2008 on (as well as to many homeowners on both sides of the Atlantic): without the easy lending that had been available before the crash, they ran out of cash when their obligations fell due.
Policymakers have two options in such a crisis: they can either bail out debtors so their debts are honored, but restrict new borrowing until the debt shrinks, or suspend or write down debtors’ past obligations, so that new creditors need not fear throwing good money after bad. Religious wisdom counsels the latter. The eurozone, fatally, chose the former.
When investors abandoned governments and banks in the eurozone in 2010, EU leaders, including Jean-Claude Trichet, the president of the European Central Bank, insisted that Greece, Ireland, and Portugal would have to pay their debts in full and back the debts of their banks to boot. Bailout loans made this possible, and in return, debtor governments agreed to slash spending, raise taxes, and pass economic reforms ordered by the “troika” of creditors—the ECB, the European Commission, and the International Monetary Fund (IMF).
Such policies were not confined to the crisis countries. Scared by the debt-market panic, all the eurozone governments tightened their belts. Although there was no sign of inflation on the horizon, the ECB raised interest rates. And instead of restructuring their own debts (giving bondholders a “haircut,” in financial parlance), struggling banks received taxpayer-funded bailouts, large enough to prevent formal
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