How did household debt help tip the world into the 2008 crisis?

Household debt helped by piling up and then going bad. The American subprime mortgage crisis, between 2007 and 2010, contributed to the wider 2008 financial crisis: households had borrowed heavily, often on mortgages built to start cheap, and when those loans failed, the securities built on them lost value. Start with the size of the debt. US household debt grew from $705 billion in 1974, 60 percent of disposable personal income, to $14.5 trillion in the middle of 2008, 134 percent. By 2008 the typical household had 13 credit cards, and 40 percent of households carried a balance, up from 6 percent in 1970.

Mortgages themselves became easier to get. Subprime mortgages grew from 5 percent of US originations in 1994 to 20 percent in 2006. Qualification rules loosened step by step, until some loans required only a credit score. Types of mortgage grew riskier too: nearly one in ten borrowers in 2005 and 2006 took out option ARMs, and about a third of ARMs from 2004 to 2006 had teaser rates below 4 percent, after which payments might double or even triple.

Then came the turn. Easy initial terms and rising house prices had encouraged people to take risky mortgages expecting to refinance quickly. When interest rates rose and prices started to fall in 2006 and 2007, borrowers could not refinance, and defaults increased as teaser terms expired and adjustable rates reset higher. By October 2007 about 16 percent of subprime ARMs were 90 days delinquent or in foreclosure, roughly triple the 2005 rate.

The shock spread because mortgage-backed securities and similar products financed the bubble: they offered higher returns and attractive ratings, yet most were made of high-risk subprime mortgages. Falling mortgage payments reduced the value of those securities. Commentators assign different levels of blame to financial institutions, regulators, credit agencies, housing policies and consumers. Afterwards, record household debt led to a balance sheet recession, as consumers paid down debts, cut spending and slowed the economy. The US lost nearly 9 million jobs in 2008 and 2009.