Debtors bear the brunt of a decline in asset prices associated with financial crises and policies aimed at partial debt relief may be warranted to boost growth in the midst of crises. Drawing on the US experience during the Great Recession of 2008-09 and historical evidence in a large panel of countries, we explore why the political system may fail to deliver such policies. We find that during the Great Recession creditors were able to use the political system more effectively to protect their

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... nterests through bailouts. More generally we show that politically countries become more polarized and fractionalized following financial crises. This results in legislative stalemate, making it less likely that crises lead to meaningful macroeconomic reforms. 2 transfers can only be approved and mediated by the political process. For example, Bolton and Rosenthal (2002) build a model in which ex-post debt forgiveness is optimal and must be approved via a voting mechanism. In this paper we investigate if such political mechanisms are feasible. Even if partial debt forgiveness is option in the aftermath of a financial crisis, creditors are going to fight any such policy. There is thus a likely political tug-of-war between creditors and debtors in the aftermath of a financial crisis. 4 We investigate the political economy of the creditor-debtor conflict using data from both the United States and other countries. Relative to European countries, the US has more lenient bankruptcy regulations allowing for a greater sharing of risk when a negative aggregate shock occurs. There is some evidence that for a given decline in house prices and a given initial leverage ratio, indebted households in the US are more likely to declare default and partially relieve their debt burdens compared to households in Europe. Nonetheless, in all of these countries, debtors are much more severely impacted than creditors in a financial crisis. We investigate the political conflict between debtors and creditors using historical crosscountry data on financial crises, as well as data from the recent US financial crisis. Mian, Sufi and Trebbi (2010a) show that both debtors (homeowners with mortgage debt outstanding) and creditors (shareholders and creditors in US financial institutions) actively lobbied their respective legislators to push for bailout legislation that would transfer resources from tax-payers to themselves. While both debtors and creditors were successful in getting their respective 4 While the analysis of this paper mostly focuses on the clash between creditors and debtors in the aftermath of a financial crisis, another interesting topic is the alignment of creditors, debtors, and political facilitators (e.g. Congress) in the expansion of debt that leads to financial crises. These are recurring observations. Romer and Weingast (1991) in their analysis of the buildup to the Savings and Loans crisis discuss the role of constituent interests and Congress in facilitating S&L gambling for resurrection through sparse and ineffective legislative and regulatory effort.