Cloud was always an outsider; the other children ignored him, and the adults blamed him for everything. When Tifa decided to go off into the mountains on her own, Cloud followed her; however, when the dangerous trail's bridge snapped and Tifa fell into a comatose state for seven days, Cloud was blamed for "taking" her there. Throughout his childhood, Cloud was told on a daily basis that he was weak, stupid, and -- God forbid -- different, and it was only a matter of time before he began to consider himself worthless.
The name "Nibelheim" was more than likely derived from "Niffleheim", the realm of the dead in Norse Mythology. Niffleheim was by no means a pleasant place and was the location of the afterlife. It is described as having been extremely cold, covered in ice, and guarded by a bloody dog by the name of Garm. It was ruled by the Norse goddess of death, Hel, whose image was split into two: one half of her body was that of a beautiful woman, and the other a rotting corpse. She was the daughter of Loki, sister of Fenrir, and was appointed to the position by Odin.
As to why Square chose to root Cloud and Tifa's hometown in such a dastardly myth, I would think it would have something to do with the double standard Nibelheim has adopted. While forcing itself to be a model town -- a place where a familiar face is always there to greet you and the Protestant ethic is embraced -- horrible things went on behind closed doors. Horrors exceeding -- though not excluding -- even Cloud's abuse in childhood.
Nibelheim is a town with a dark secret: it is home to the Shinra Mansion in which terrible experiments were committed in secrecy. SOLDIERs who were not of immediate value were treated like animals, mutated beyond recognition to become hellish beasts locked away in the nearby reactor--all in the name of science. Furthermore, after the incident at the Nibelheim reactor that left the town in ruins, it was rebuilt by Shinra as an elaborate cover-up and the perfect location to continue their experiments to create the ultimate fighter, the Sephiroth clones. As a result, when Cloud returns to his home during the events of the game, he discovers that it is inhabited by mindless drones -- beings twisted to serve one purpose that are dead to the world in every respect. Throughout the team's stay in Nibelheim, the town gives off and eerie, still aurora, as if the place has not really been lived in for years; although there are the actors and "normal" inhabitants in place to further enhance Shinra's cover, even the best actor can't duplicate the feeling of genuine familiarity and homeliness that is so crucial to the hometown Nibelheim always strove to be. For all intents and purposes, Nibelheim is dead, and Shinra is just rattling the corpse.
