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Against the longstanding (Augustinian-Lutheran) interpretation of Judaism as a "religion of legalism" which promoted self-righteous efforts to merit salvation before God through human good works, Stendahl—later followed by Sanders and the rest of the New Perspective on Paul writers—argued that Judaism was always (and still is) a religion of grace, faith, and forgiveness.
Nothing in the Hebrew scripture ever called humans to self-salvation—meritorious acts that would earn God's favor. Biblical religion was always a religion of covenant, rooted in the free, undeserved election of Israel by God. This covenant faith was structured by moral and purity laws and underpinned by a sacrificial system specifically designed to provide a means of atonement/forgiveness for men when they fell short of covenant obligations.
Specifically, Stendahl attacked the persistence of the guilty conscience in western culture rising from Augustine's (and furthered by Luther's) reading of Paul. Augustine saw Paul in Romans 7 as a man languishing in guilt, paralyzed by his moral shortcomings, and given to the "unrelenting introspection" that has come to characterize the western mind.
In contrast, Stendahl held that while Paul genuinely felt the weight of his chief sin—persecution of the church—he put any crippling guilt behind him and lived triumphantly in the grace and forgiveness of God. (Stendahl offers a parade of Paul's autobiographical statements to support his interpretation.) Romans 7, Stendahl shows, is part of Paul's larger argument about the role of the law in demonstrating the power of sin over "the flesh."
Paul happened to express this supporting argument [in Romans 7] so well that what to him and his contemporaries was a common sense observation appeared to later interpreters to be a penetrating insight into the nature of sin. (Mark A. Mattison, A Summary of the New Perspective on Paul)
Stendahl argues that Protestants should no longer assume Paul was battling against Jewish legalism—since Paul's opponents never taught that salvation was merited/earned by human works. Rather Paul and his "Judaizing" opponents both shared the Jewish religion rooted in grace, election, and covenant. Romans 7 must be understood as something other than a sinful man consumed and wallowing in his guilty conscience.