Why were house prices going up like crazy during the housing bubble?

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Why didn't the stupid high prices deter people from buying more houses?

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People don't buy houses all cash. They use leverage. As long as you can "afford" the monthly payment on bigger and bigger mortgages, the price will go up as those folks bid up the price.

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Why didn't the system correct itself? 

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It did. The market crashed remember?

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Did the bubble burst because people couldn't pay the mortgage or did they just run out of suckers to buy more houses? 

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Both. Going back to the top. For some, their loans were teaser rates that adjusted up. What was once a mortgage they could pay became one they could not.

A domino effect occurs. Those mortgages fail, which causes money to suck out of the economy leading to job loss, causing more mortgages to fail and so on.

It's human nature. Speculative bubbles have been created and burst as long as investments/gambling have been around.

tulips and bubbles

Humans have an instinctive urge to take risks to acquire goods/power/money/whatever. As long as the objective continues to increase in value, people continue to buy it regardless of the cost if they expect the selling price increase further. It's not a question of whether the house is worth the asking price or cost or value, it's a question of whether the buyer believes the selling price will be higher in the future.

Stocks, houses, tulips, gold, or whatever have values based on what people think other people will pay for them later. As long as enough people believe prices will rise, they will.