It's called the wealth effect. It's that warm fuzzy feeling many of us enjoy when we sit back and contemplate our rising house values, investment portfolios and superannuation balances.

Over the past 15 years the net worth of the average Australian has risen substantially. In its Summer Economic Roundup, Federal Treasury estimated household net worth had reached more than $5 trillion by June 2007, an average of $600,000 a household. It grew by 11.6 per cent from June 2006 and had risen by an average 10.6 per cent a year this decade.

The Reserve Bank says household net worth last September was almost seven times annual household disposable income - up from about five times income in the mid-1990s.

Most of our assets are still in housing but we've been riding the bull sharemarket too, with the Reserve Bank reporting financial assets held by households rising by 17 per cent in the year to September. Thanks to compulsory super, even low-income earners have seen their wealth increase as super balances have grown.

But there's a downside to this wealth we're all so fond of. Much of it has been brought about by debt.

And as economies worldwide sort out the fallout from the global credit crisis, too much reliance on debt is emerging as a very bad thing.

Associate Professor Steve Keen, of the University of Western Sydney's school of economics and finance, is one commentator who finds the level of debt in Western countries alarming.

Keen says we're living in a debt bubble that dwarfs those of 1892 and 1931 - the time of the Great Depression. He has analysed Australian and US debt compared with gross domestic product.

At the bottom of the 1990s recession, he says, Australia's debt was about 78 per cent of GDP. It is now 165 per cent. That's more than doubled over the past 15 years. In 1892, he says, debt peaked at 104 per cent of GDP and in 1931 it peaked at 77 per cent.

Keen says the US figures are even more startling, with total debt now totalling about 370 per cent of GDP compared with about 300 per cent back in 1932.

The general manager of MLC's investment management division, Michael Clancy, says the past 10 to 20 years has seen enormous growth in borrowings by individuals, investors with margin loans, hedge funds, private equity groups, and others.

"The build-up started in 1987 when then Federal Reserve chairman, Alan Greenspan, basically told the market the Fed would be there to provide liquidity if ever the market got itself into dire straits," he says. "That sent the message that you could go out and take risks and if you screw up, it will bail you out."

Clancy says this message has been reinforced by the central bank's actions through a range of crises since then. Coupled with lower interest rates and more competition between lenders, it created fertile ground for a debt binge.

"[The growth of debt] has been going on for a long time," he says. "And it's not a danger until the music stops. But as soon as it does and sentiment turns, the whole system seizes up. That's what we've seen in wholesale credit markets over the past six months."

True to form, the Federal Reserve has been addressing the credit crisis through lowering interest rates, providing liquidity and even helping bail out investment bank Bear Stearns. How successful it will be remains to be seen but Clancy says excessive leverage has already generated hundreds of billions in losses and a massive ripple effect.

Those hardest hit are those who have borrowed most - overleveraged financial institutions and companies, executives and lenders with big margin loans, over-extended mortgage borrowers and investors in geared investments that have either been frozen or fallen further in value than the underlying markets.

But no one gets off scot-free.

Investors already have been hit by falling share prices, the US economy is teetering on the edge of recession and, despite Australia's stronger economy, debt is starting to take its inevitable toll on household wealth.

Wealth researcher Simon Kelly, an associate professor at NATSEM, says most of our wealth is still in housing. So news that property prices had a sluggish start to the year will come as unwelcome news to most households. APM reported prices of houses in Sydney and Melbourne were virtually unchanged in the March quarter and Sydney unit prices declined by 2 per cent.

Kelly says super is also growing as a component of household wealth, so a wider range of households will be affected by the sharemarket downturn.

At this stage, Kelly says, the falls have not been sufficient to trigger a likely fall in household wealth but growth will have slowed and this is likely to affect confidence.

The graphs show the clear relationship between rising wealth and our willingness to borrow.

Unlike 1987, when the sharemarket fell and businesses were left struggling with high levels of borrowings over assets that were no longer worth as much, Australian companies have generally been more conservative with debt through the latest boom.

"Business has deleveraged over the past 15 years," says ANZ's chief economist, Saul Eslake. "This time around the capacity of business to withstand interest rate rises is much greater than it was in the late 1980s and early 1990s."

In its March Financial Stability Review, the Reserve Bank noted an increase in business gearing levels, at least partly due to businesses turning back to bank debt for funding as the credit crisis made it more difficult to raise money elsewhere.

But while some companies obviously have too much debt (the recent problems of groups such as Centro and MFS are clear evidence of that), it found strong profits in recent years have allowed many companies to finance investment without loading up on debt, leaving company balance sheets in good shape.

But consumers have been borrowing in spades. Keen's analysis shows households have debt of about 100 per cent of GDP, while business debt is about 65 per cent of GDP. As the graphs show, the ratio of household debt to disposable income has been rising steadily since the 1980s and the average household today has debt of more than 150 per cent of its income.

"In the 1990s household debt was about 40 per cent of disposable income; it's now 160 per cent," says AMP Capital Investors' chief economist and head of investment strategy, Dr Shane Oliver. "That means a 1 per cent rise in the mortgage rate back then is roughly equivalent to a 0.25 per cent rise today."

Oliver says Australia has moved from being one of the countries at the bottom of the pack in terms of household borrowings to one of the biggest borrowers - though we're still behind Britain.

Why did we take on so much debt?

Eslake says there are four main reasons. First, thanks to low interest rates, debt has been cheap.

"If people were prepared to spend a certain proportion of their income servicing debt when interest rates averaged 14 per cent, almost by definition they would be willing to take on more debt when interest rates were lower," he says.

Eslake says low interest rates also allowed some borrowers, who may not have been able to afford a loan when interest rates were higher, to take on debt.

A second reason we took on more debt is that we have gone for 17 years without a recession.

A stable economy has eased our fears of high inflation and interest rates, and lessened the chances of unemployment.

New lenders entering the market, and greater competition between lenders, also played a part. And then there's the wealth effect. Consumers are rational people. If we believe house prices are going to rise, we'll willingly take on a big mortgage to get into the market. If we believe shares will generate strong returns, we'll be more inclined to borrow to buy them than if the outlook is uncertain. And if we're fortunate enough to be sitting on assets that have risen in value, why not borrow against them to buy other investments, or to fund an overseas trip, new car or plasma TV?

Kelly says the baby boomers have forged the new attitude to debt. Having borrowed to buy houses that are now worth much more than they were, the boomers have led the trend to borrow against the equity in their homes for other purposes.

Thanks to the fact that asset values have been rising even faster than debt levels, the balance sheet of Australian households shows relatively modest levels of gearing. In fact, so far as averages go (and, as Eslake points out, averages can cover up a lot of sins), Australian households are among the most comfortable in the world. The net wealth (after borrowings are taken out) of Australian households is about 10 times their disposable income - lagging behind Britain but ahead of Canada, Germany, Japan and the US.

Oliver says net wealth may have come back a little in the last quarter with falling share prices but overall net wealth would still be reasonable.

"[Despite rising debt] household balance sheets have been in very good shape for the past few years thanks to rising asset prices - first house prices, then share values," he says.

"Rising debt is fine if asset values are going up and you can be beguiled into thinking everything will be OK. But when asset prices start to fall, [debt] can lead to a rapid deterioration in balance sheets." Eslake says we've been in a "virtuous cycle" where rising asset prices encouraged consumers to take on more debt, which further fuelled asset prices and increased the collateral on which further debt could be raised. So long as such cycles remain intact, he says, debt can be productive. But he says virtuous cycles can quickly become vicious if people are forced to sell assets. That drives down prices, which drives down the willingness and ability of people to borrow, which leads to further sales ... And so on.

So far, Eslake says, households in aggregate are not in this vicious cycle. But that's not to deny that individual households are finding it tough and some are being forced to sell assets to repay their borrowings.

For that virtuous cycle of wealth to turn vicious, he says, we'd need interest rates to rise to a level where large numbers of home owners were forced to sell. That is what is occurring in the US.

Forced sales could also be generated by a sharp rise in unemployment, an abrupt drop in immigration numbers or - theoretically, at least - a huge injection of cheap new housing by Government.

"At the moment debt is not a serious concern [for households overall] but if [the downturn] drags on for a while, households are a lot more vulnerable than they were in the 1990s," Oliver says.

"The real risk is if we have a hard landing or recession."

Clancy says there are already signs that higher interest rates are reducing consumers' willingness to spend and borrow. At the same time, he says, banks have become less inclined to lend (particularly to more marginal borrowers) as their own capital has become more precious.

Kelly says weaker home prices and the sense that we're not getting wealthier any more also have reduced consumer confidence in debt.

Others, such as Keen, believe the debt reckoning is still to come.