The initial impetus to increased borrowing by developing nations was the oil crisis of 1972–74, when the price of oil quadrupled over a two-year period. This increased price put tremendous pressure on the industrialization programs of countries that relied heavily on oil imports and at the same time sent a huge volume of “petro-dollars” into the coffers of the international banking community. Eager to recirculate this money, the banks began to offer low interest loans to even relatively high-risk borrowers, including many developing nation governments. For oil-importing countries, this provided capital to continue the development programs regardless of the increased cost of oil, and for those few countries that were oil exporters, the money was borrowed on the basis of the oil revenue bonanza to come. However, the second oil crisis of 1979–80 closely followed by the interest rate hikes of the early 1980s, and the deep global recession of 1981–82 left many developing countries with insufficient income to pay back their loans on schedule. These loans, often made for current consumption rather than to build economic capacity, also came at a time when the global economy had been destabilized by the ending of the Bretton Woods system and when there had been an overall decline in the terms of trade for products from the developing world. As countries came increasingly close to defaulting on their loans, the IMF emerged as the guarantor of creditworthiness for developing countries regardless of the lender. Part of the new guarantee process involved countries undergoing IMF structural adjustment programs, which were designed to address balance of payment problems generated by internal problems such as high inflation, structural inefficiencies, and large budget deficits. The IMF program was designed to reduce current consumption so that capital could be invested in future economic growth.

However, in the case of heavily indebted countries, it merely freed money to flow out of the country and back to the lenders, and led to austerity programs at home that had potentially devastating effects on human and physical capital as food and transport subsidies were reduced, health and education programs cut back, and taxes raised, even as public sector employees were laid off. In addition, requirements for increased export income often shifted agricultural production from local food supplies to export crops, increasing local food costs. Since the 1980s, the focus of the international financial community has been to restructure this debt to reduce the chances of large scale default. A wide variety of programs, including debt for nature swaps; debt for asset swaps, which give creditors the ability to buy physical assets in the debtor country at a deep discount; and cash buy backs, which allow the creditor to buy back the loan at a deep discount. More recently, as it has become apparent that such programs are only having a minimal impact on debt reduction, particularly in the poorest countries, the concept of debt forgiveness through programs such as the Millennium Development Goals is becoming increasingly common.

Historically, personal debt has been viewed by many societies as immoral, but modern economic perspectives often see consumer debt as beneficial to the economy as it increases domestic production and enhances economic growth. Governments may even encourage debt through tax relief for certain types of interest payments, if the loans are used in ways that encourage consumption of domestic products (for example mortgage interest relief in the United States).

The most common forms of secured personal debt are mortgages. However, there has been a large increase in unsecured personal debt in most developed countries over the past few decades, and the rising use of credit cards, payday loans, tax rebate loans, and consumer financing has led to record levels of private debt in many developed countries.

The sales of a company for a given period, for example, may be considerably higher than its cash receipts; the reason for this may simply be that the company’s customers may paying late or may have favorable “stretched out” payment arrangements. Similarly, the costs of a company, as recorded on its books, may be lower than its actual cash payments in a period; the company, for instance, may be prepaying insurance for the next six months this month; it’s books will only show one sixth of that payment as cost but six times as much going out as cash. For these reasons, a company may be profitable based on its books but may be short on cash at any given time. Lenders therefore like to look at the amount of cash available to service the current portions of any new debt. If this amount is minimally 1.25 times the debt service required, the business is at least in the ballpark to receive a loan. The higher this ratio, the more inclined the lender will be to lend.

Rules of thumb along these lines are subject to adjustment based on the availability of money. As Daniel Rome Levine pointed out early in 2006, commenting on the money market in Chicago, writing for Crain’s Chicago Business, “[S]ince the 2001 recession, many entrepreneurs have learned to do more with fewer resources and pared down their debt.” Interest rates were low and banks were loosening their terms. “These days,” Levine wrote, “[banks] are going as low as 1.1 times debt for companies with strong balance sheets.” A tightening of money and less favorable small business profiles will once more push the ratio up.

Debt financing, by contrast, is cash borrowed from a lender at a fixed rate of interest and with a predetermined maturity date. The principal must be paid back in full by the maturity date, but periodic repayments of principal may be part of the loan arrangement. Debt may take the form of a loan or the sale of bonds; the form itself does not change the principle of the transaction: the lender retains a right to the money lent and may demand it back under conditions specified in the borrowing arrangement.

Lending to a company is thus at least in theory more safe, but the amount the lender can realize in return is fixed to the principal and to the interest charged. Investment is more risky, but if the company is very successful, the upward potential for the investor may be very attractive; the downside is total loss of the investment.

The period after World War II (which ended in 1945), however, was marked by a number of economic developments in the United States, including the mass production of consumer goods, the increasing urbanization of American society, and the advent of consumer credit. By the 1960s more and more Americans were taking on consumer debt, and there was a dramatic rise in the number of personal bankruptcies. (Bankruptcy is a declaration of financial insolvency, or inability to pay off one’s debts.) Alongside these trends, independent lending companies began to offer debt consolidation loans to households in financial crisis. Many of them charged exorbitant interest rates. The practice of taking advantage of people in financial trouble by lending them money at very high interest rates or charging high fees to initiate the loan is called predatory lending.

If you own your home, the best way to consolidate your debt is usually with a home equity loan (also called a second mortgage). With this kind of loan, you borrow against the amount of equity you have in the home. Equity is the difference between the market value of the home (the amount you could sell it for) and the outstanding balance on your original home loan. So, for example, if your house is worth $240,000 and you owe $195,000 on your mortgage, then you may be able to borrow up to $45,000 (the difference between the two numbers) with a home equity loan. Because a home equity loan is secured (the home is your collateral), the lender regards it as a lesser risk than an unsecured loan and will usually offer you a more favorable interest rate. Also, the interest you pay on a home equity loan (as with a regular home loan) is often tax deductible, meaning it can help reduce the amount of annual income tax you have to pay.

If a person does not own a home or other property that he or she can use to take out a secured loan, it is possible to obtain an unsecured debt consolidation loan. The Federal Trade Commission (a U.S. government agency) and other consumer-protection groups caution consumers to choose carefully among the private companies that offer these loans. Many do not fully disclose the fees and other terms associated with their loans, and they may make inflated or false promises about their ability to alleviate debt.

In general, many critics warn that debt consolidation loans are not the cure-all that many people think they are. The problem with debt consolidation, they say, is that it makes you feel as though you have taken care of your debt problem, when in fact you have only rearranged the problem. Debt consolidation may get you a lower interest rate and a lower monthly payment, but it does not make the debt go away. Also, many people do not realize that a lower monthly payment often just means that the term of the loan is extended; thus, even with a lower interest rate, stretching the loan out over a longer period may ultimately cause the borrower to pay more interest.

Moreover, a debt consolidation loan does nothing to help someone change the spending habits that got him or her into debt in the first place. Indeed, according to one study, more than three-quarters of the people who consolidate their debt and clear their credit cards gradually build balances back up on those empty cards.

One reason people consolidate their debts under a new loan is to secure a lower interest rate (the interest rate on a loan is the percentage of extra money a borrower pays per year on top of the balance of money owed; it can be thought of as the cost of borrowing the money) or even simply to secure a fixed interest rate. Unlike a variable interest rate, which fluctuates according to changes in the economy, a fixed interest rate remains the same until the entire balance of the debt is paid off.

Some people take out debt consolidation loans in order to make their debts easier to manage. Rather than keeping track of several different payments to different creditors (or lenders), which may all be due at different times during the month, a debt consolidation loan enables the borrower to make one easy payment per month. With only one due date to remember, the borrower greatly reduces the risk of missing a payment and incurring costly late-payment penalties.

A third reason for a debt consolidation loan is that the minimum payment on such a loan is often less than the sum of several minimum payments on smaller debts. If the borrower uses less of his or her monthly income to pay off debt, it should be easier for him or her to handle basic monthly expenses for housing, food, utilities, and such. Some financial advisers say that if the borrower can live more comfortably within his means, he will be less likely to continue to build more debt.

As of 2007 around 144 million Americans had at least one major credit card, and the average American family had eight different cards. Of the 144 million cardholders only 55 million regularly paid the full balance (the total amount owed) of their credit card bills every month. Nearly 90 million Americans, then, owed not just the amount of their balances to credit card companies but were also paying interest and fees that were often very high. People with poor credit histories (a record of late and missed payments), for instance, might be charged a yearly interest rate of around 30 percent, and the average balance for those who maintained a balance from month to month was estimated at $13,000. Thirty percent interest on a balance of $13,000 would amount to an additional charge of $3,900 a year, not counting additional fees commonly assessed by card companies. Of the 90 million people who habitually failed to pay their monthly balances, approximately 35 million made only the minimum payment of 2 percent of the total balance each month, which amplified the effect of interest and fees and extended the amount of time they would likely remain in debt.

Several conditions are necessary to support an economic system in which debt plays such a big role. First, the members of such a society must be likely to repay what they owe. A credit system in which most people try to avoid payment is unsustainable. Second, there must be a sophisticated legal system that emphasizes the protection of private property. A debt is a loan of one person’s or organization’s private property to another person or organization; if debts are to be reliably collected, laws must be able to defend creditors’ property rights. Third, the society’s money must maintain its value. When a country’s currency is unstable (that is, when its money tends to lose or gain value erratically as a result of rising or falling prices), then a creditor cannot count on the value of the money he or she will eventually be repaid.

Most debt is transacted not by borrowers and lenders in direct contact with one another but by intermediaries, such as banks. Banks take in money from depositors and lend it out to borrowers. Depositors are paid interest by the bank for the use of their money, and the bank charges borrowers a somewhat higher rate of interest. The difference between these rates of interest is one of the key sources of any bank’s profits.

Debt is often based on created money: figures on paper (or in computer systems) rather than hard cash. Banks do not hand over actual coins and bills to borrowers. Instead, they give borrowers a checkbook with the amount of the loan recorded as a balance (the amount of money available) in a checking account. People can write checks or withdraw money that is subtracted from these balances, but a bank does not have actual currency on hand equal to the full value of all its bank accounts. Banks make loans, instead, in proportion to a small amount of currency that they are required by law to keep on hand. If, for example, Community Bank has $10,000 in currency, it might need to keep only $1,000 in reserve and can lend out the rest. The borrowers then take the money and place it in a bank account, which can then be lent out to other borrowers. This process continues, and the initial $10,000 in currency allows Community Bank to make loans equal to 10 times that much money. Community Bank thus literally creates 90 percent of the money in its accounts out of thin air.

This form of money, which exists only as numbers in banks’ computer systems, accounts for much of the total money supply in a country at any given time. In 2006, for instance, there was about $800 billion in physical cash in the United States. If the money supply had been calculated to include not just cash but also checking, savings, and other forms of bank accounts (all of which represent money owed by banks to account holders or by borrowers to banks), however, it would have amounted to more than $7 trillion. Debt, therefore, is one of the chief sources of the nation’s money supply. Its importance to the economy can hardly be overstated. Not only does debt fuel business ventures, make possible large purchases, and allow for the construction of highways and the fighting of wars, but it also provides much of the basic material (money) for the entire economy.

Furthermore, prior to the twentieth century most societies dealt very harshly with debtors. In ancient Greece, Rome, and Israel, among other early civilizations, debtors who could not pay what they owed were sold into slavery, though Israeli custom required the freeing of such slaves every 50 years. The feudal system of the Middle Ages (in which aristocrats, or those belonging to a small privileged class with inherited land and wealth, ruled over all the people who lived on their land) generally treated debtors more leniently. This was true only because all men were required to serve their rulers in the military and could not be spared for the purposes of punishment. As the Middle Ages came to an end and capitalist economies (in which individuals could own property and conduct business with some amount of freedom from feudal or government control) began to develop, harsh treatment again became the norm for debtors. Until the nineteenth century people who could not pay their debts were generally sent to prison.

Even though debtors’ prisons were phased out in Europe and the United States in the mid-nineteenth century, most people continued to frown on the practice of going into debt except to purchase the most necessary items. Debt was considered irresponsible and even immoral, an attempt to acquire things one could not afford to buy by honest means. Only essential investments, such as a farmer’s purchase of seeds or a company’s construction of new factories, were seen as legitimate reasons for borrowing money.

Throughout history governments have borrowed money in order to conduct wars. Only in the aftermath of the Great Depression (the severe financial crisis that afflicted the world economy in the 1930s), however, did government debt during peacetime became routine. National governments found that they could stimulate their ailing economies by spending money (often on public projects and on aid to the unemployed, the poor, and the elderly), and this was seen as beneficial even if the money had to be borrowed. Since that time public opinion of government debt has fluctuated, but governments have continued to borrow money for peacetime needs and with the intent of managing the economy, as well as for the waging of war.