US household debt hit a record $16.15 trillion in the second quarter of 2022. Mortgage debt accounts for 75% of the total; college debt another 10%. The rest is mainly motor vehicle and credit card debt.

Rising household debt over the past two years is worrisome, and will become a greater problem as interest rates continue to rise. What’s more worrisome, however, are its consequences. Excessive debt can force people to reduce their spending, which will slow economic growth and lead to a recession.

$16 trillion is a large number. But what really matters is debt relative to what people have to repay it. College debt exceeding $100,000 is not a big deal for doctors and lawyers making several times that amount each year. The situation is very different for teachers making half what they owe.

From this perspective, things have gotten better lately. Household debt relative to disposable income fell from 150% in 2009 to 130% in 2016, where it has since remained; and household finances improved during the coronavirus pandemic. Consumer debt payments (which excludes mortgages) relative to disposable income fell from 13% in 2007 to 8.4% in early 2021. Delinquencies (debt payments 90-plus days overdue) fell from 3% before covid to under 2% in 2020 and 2021. Covid (which kept people at home and reduced spending), low interest rates, and generous government benefits during the pandemic (stimulus checks, child tax credit, and a moratorium on repaying college debt) helped bring this about.

Furthermore, debt isn’t always bad. Mortgages let households purchase a home and gain equity when they pay it off. Borrowed money lets people attend college and buy cars. Debt also enables people to survive hard times– a layoff, gig workers getting fewer gigs and non-gig workers getting fewer hours, or any catastrophe precluding employment for some time. However, high debt levels make life stressful and difficult. People worry about eviction, utilities being shut off, putting food on the table, as well as saving for retirement.

Household debt also stimulates the economy and creates jobs. But this, too, is a double-edged sword. Even a small spending cutback due to high debt levels will have negative macroeconomic consequences. Inventories will pile up, firms will cut production, and lay off workers. Service-sector workers will receive less income, and have their gigs or hours reduced.

The main force reducing consumer spending since the 1980s has been the greater share of total income going to the rich, who save large fractions of their income. This leaves less for households struggling to maintain their standard of living. Since low- and middle-income households typically spend nearly all their income, these households have gone into debt or deeper into debt.

But households can handle only so much debt. While the actual breaking point is uncertain, the economic results can be catastrophic once this limit is reached.

In 2008, the Great Recession began when homeowners couldn’t pay their mortgages. Lehman Brothers collapsed, and many other financial institutions stood on the brink of bankruptcy. The government bailed out the financial institutions that created the problem, but then did little to help households saddled with mortgages they couldn’t possibly repay. This is one reason the economic recovery was so weak and it took nearly a decade before household income (adjusted for inflation) reached its pre-2008 level.

A similar problem led to the October 1929 stock market crash and Great Depression. During the Roaring 20s people bought stock on borrowed money. Once stock prices fell a bit, margin calls went out. Lacking sufficient savings to repay loans from stockbrokers, people had to sell stocks to get cash and repay their loans. This pushed down stock prices further, generating more margin calls, and eventually a market crash. What happened on Wall Street soon affected Main Street, as everyone became reluctant to spend money.

While household debt levels have not yet approached a tipping point, four forces will sharply increase debt-to-income ratios in the months ahead.

First, the Federal Reserve has been raising interest rates since early this year. They plan to continue doing so at least through the end of 2022 (see “The Fed’s Battle with Inflation: A Pyrrhic Victory? Or Will the Federal Government Join the Fight?” in the July/August 2022 Washington Spectator). This will increase rates on credit cards, college debt, and car loans. We have already seen one consequence of this– the ratio of consumer debt payments to disposable income rose to 9.5% in the second quarter of this year (from its record low of 8.4% last year).

Second, the majority of household debt comes from housing. Home prices grew 4.5% annually from 1992 to 2019. Starting in 2020, they have soared more than 10% a year, resulting in a nearly 40% increase in home prices between 2019 and today. Homes are less affordable now than at any time since June 1989. As the Fed continues raising interest rates, housing prices will begin to fall, putting some homeowners underwater. Similar to the Great Recession, many won’t be able to repay their mortgages and will lose their homes.

Third, President Biden recently announced that the college debt moratorium would end in 2023. This moratorium is a leading reason household debt was less problematic during the covid pandemic. Income not used to repay college debt went to repay other debt and kept people from falling further into debt. When college loan repayments resume in January, many households will struggle to pay their bills and also repay their debt.

Finally, government benefits helped US households during the coronavirus pandemic. These benefits have ended. Families struggling to make ends meet must now rely on high-interest borrowing (credit cards, payday loans and auto title loans) to survive.

The good news is that financially strapped households can be helped. For starters, the Fed can stop raising interest rates before they push the economy over the edge.

A more difficult fix is meaningful bankruptcy reform, including allowing people to discharge their college debt, rather than being squeezed during their working lives and then having whatever they still owe taken from their Social Security checks.

Before the 2005 Bankruptcy Reform Act it was easy and cheap for people to reduce their debt through bankruptcy. This is no longer the case. Now people must take two credit counseling courses before having their debt reduced. Many studies have found these classes to be worthless. They don’t change behavior, but they are costly for people already drained of their financial resources. Moreover, delaying bankruptcy protection leads to abuse by creditors and possible loss of one’s home and car.

For many people, bankruptcy is the only option to escape from the crushing debt that comes from job loss, enormous medical bills, divorce, and other unanticipated events. Changing the bankruptcy code is needed. Towards this end, Elizabeth Warren (D-MA) introduced a new bankruptcy bill in the Senate in 2020. It remains stuck in Committee, lacking the votes to end a Republican filibuster.

A more liberal bankruptcy law would help, but it doesn’t solve the underlying problem. People accumulating great debt, and then eliminating it in bankruptcy court every half- dozen years or so, epitomizes Einstein’s quip about insanity–it is “doing the same thing over and over and expecting different results.” The root cause of the household debt problem–greater inequality–needs addressing. As noted above, when more income goes to the top 1%, everyone else must pick up the slack by spending more or going into greater debt. If this doesn’t happen, economic growth slows and household debt levels become more problematic–not due to more debt but due to having less income to repay that debt. This is why higher taxes on corporations and the rich, and more generous spending programs (for example, reviving the refundable child tax credit and increasing Social Security and Medicare benefits), are needed. It is for the good of the economy and the nation.

Unless some action is taken, household debt will continue to rise. And it will threaten to rise to the point where it breaks the backs of American households and the US economy.

Steven Pressman is part-time professor of economics at the New School for Social Research, professor emeritus of economics and finance at Monmouth University and author of Fifty Major Economists, 3rd edition (Routledge, 2013).