Last week it was announced that our economy contracted 4%, a sharp decline from the 3.7% growth in the 4th quarter of 2007, and I’m sure many of us know the reason why: the mistakes of banks who made bad loans and called them AAA-quality assets. Sure, they made mistakes due to lax oversight, but is the blame all theirs?

For English and History of Economic Thought, two classes I’m taking, I am learning that interest (or “usury”) was a sacred thing that can be requested only in special economic circumstances, and only up to the lender’s opportunity cost. But if the interest was part of the deal, the borrower was required to pay–even with flesh (or otherwise by the repossession of personal assets) if need be. Isn’t the true fault of our current credit crisis Americans’ acceptance of taking out loans they cannot possibly repay?

Instead, if they’re running low on money, they can just file for bankruptcy. Sure, it hurts their credit, but credit is a much weaker incentive than the social incentive that disappeared with the creation of credit. People stopped becoming socially motivated to maintain good credit and good reputation (Not just money-wise) when electronic credits replaced that motivation.

That needs to change.

Just as how imposing a late pick-up fine at a daycare increases the number of kids who are picked up late because the economic incentive replaces the social (and much stronger) incentive, simply making people who can’t afford things already pay more for loans and credit is not going to work. Instead, Americans need to be taught that they should refrain from taking out loans they cannot afford, and to put their full assets at the mercy of repossession should they lose the ability to make their payments. Bankruptcy laws shouldn’t be so lax that everyone gets an infinite amount of “Let’s try that again.”

Individuals know more about their living circumstances than even the smartest banks. Let’s make the judgment of personal solvency the responsibility of the borrower. If people only took out loans they could afford, we would be at a stable, non-bubble economy with real growth, and we wouldn’t have lost trillions of dollars in wealth and capital.