The role of private debt as a cause of financial crises and prolonged recessions is often neglected. In Cyprus policy concern has focused on government debt despite the problem of a rapid growth of private debt and its wasteful use. Private debt in Cyprus stands at over 350% of GDP, but the European Commission’s policy of austerity and encouraging the redeployment of private assets through bankruptcy is based on a misdiagnosis of the problem. Studies of the importance of private debt and balance sheet recessions following financial crises conclude that policy-imposed austerity can only worsen and delay economic recovery. In Cyprus there is scope to raise productive government expenditures through using European Union funds, by raising revenue from the large base of unpaid taxes and by taxing the large shadow economy estimated at over 25% of GDP.