A key factor in the current U.S. economic crisis is that many American households borrowed and spent more than they could afford. Changes in lending practices helped lead many people to make disastrous financial choices - choices that fueled a national economic crisis.

Consumer finance expert Robert Manning goes as far as to say, "It's a consumer-led recession rather than a business cycle recession." He says the recession is connected to household borrowing. "Americans have reached a point where they're at a historic and unprecedented level of consumer debt."

Falling wages and relaxed regulations

Manning is the founder of the Responsible Debt Relief Institute, a non-profit organization that produces financial counseling software. He claims that this increase in borrowing was tied to a drop in real wages.

"Between 1982 and 2001, real income increased 20 percent. Since 2001, real income in the United States has declined about 2.5 to 3 percent," he says. "Americans were making up the difference with easy access to relatively cheap credit."

Manning says credit was more widely available because a loosening of federal bank regulations encouraged private financial institutions to focus more on short-term gains. "What we saw in this era of deregulation is that everybody was simply driving to make profits on a quarter-by-quarter basis."

Hedge funds also played an important role. "These are companies that are completely unregulated," he says. "They made huge amounts of money in a short period of time. It put pressure on a lot of other financial institutions to take greater risks."

Easy money for consumers

For example, Manning says credit card companies loaned larger sums at lower interest rates. And banks began to offer home mortgages to more people on terms that were very appealing in the short run.

"People were getting approved for loans for the cost of a house that was maybe twice to three or four times what they could really afford," says Manning. "They could get an adjustable rate mortgage where [for] the first two years [the interest rate was] maybe 1.9 or 2.9 percent. The loans would later reset at much higher interest rates and the borrower's monthly payments would increase."

Leslie Linfield of the non-profit Institute for Financial Literacy says these so-called subprime mortgage loans and other high-risk lending products marked a dramatic change from what financial institutions used to offer.

"I started my career as a banker in the '80s, and we had just a handful of products," she says. Now, things are different. "You walk into the branch of any bank or credit union, they have to whip out a three-ring binder, and they don't understand what they're trying to sell. The customer is equally confused."

Such ignorance about these new types of loans, Linfield says, led to poor decisions.

A cycle of cheap credit and rising home prices

So long as housing prices continued to rise, Manning claims, no one was worried about what would happen if borrowers couldn't make the larger payments.

"So all of these aggressive marketing tactics drove up the price of houses," he says. "When people defaulted on those loans in '04, '05 or '06, they could sell these houses still for more than they were worth. Investors would always get their money back."

Manning says the housing market also allowed consumers to ignore their mounting credit card debt.

"The bank would turn right around and say, 'Why don't you refinance your $50,000 in credit card debt into your home, because it's gone up in value?'" 

Consumers would take out a home equity loan, a loan based on the value of the home that they owned, and use it to pay their credit card balances.

Sam Gerdano of the American Bankruptcy Institute says homeowners bought into a common myth about housing prices.

"They were assuming that homes would always increase in value," he says. "Maybe somebody told them that; maybe somebody told them that a house was their best investment or any of the other fallacies."

Collective faith in these fallacies, most experts agree, contributed to the so-called housing bubble. Eventually there were simply too many houses going up for sale on the market.

"When these people would go into default and foreclosure, the homes weren't sold and the investors started to lose enormous amounts of money by 2007," Manning says. Matters only got worse that year as home foreclosures began to increase dramatically.

While many analysts blame that trend on the nation's lending institutions, Gerdano says there's enough blame to go around.

"Everyone has responsibility," he says. "Both the borrowers and the lenders have contributed to the state we're in today."

And both groups face complex challenges in the months and years ahead cleaning up their respective financial messes.