An interesting article in the Wall Street Journal today ( full article) describes credit cards as the next piece of the debt/credit pie to go.  The author makes some powerful points that I’d like to point out.  First, describing the role credit cards play in today’s economy:

…there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon. While those numbers look small relative to total mortgage debt of over $10.5 trillion, credit-card debt is revolving and accordingly being paid off and drawn down over and over, creating a critical role in commerce in America.

The issue comes about with credit card underwriting standards.  As they have been far too optimistic over the last 10 years.

There are several factors that are playing into this swift contraction in credit well beyond the scope of the current credit market disruption. First, the very foundation of credit-card lending over the past 15 years has been misguided. In order to facilitate national expansion and vast pools of consumer loans, lenders became overly reliant on FICO scores that have borne out to be simply unreliable. Further, the bulk of credit lines were extended during a time when unemployment averaged well below 6%. Overly optimistic underwriting standards made more borrowers appear creditworthy. As we return to more realistic underwriting standards, certain borrowers will no longer appear worth the risk, and therefore lines will continue to be pulled from those borrowers.

What can be most alarming of all is the unintended consequences brought about by these shifts and changes.  Unintended consequences are the pieces that are so frequently left out of consideration (especially with government planning).

Second, home price depreciation has been a more reliable determinant of consumer behavior than FICO scores. Hence, lenders have reduced credit lines based upon “zip codes,” or where home price depreciation has been most acute. Such a strategy carries the obvious hazard of putting good customers in more vulnerable liquidity positions simply because they live in a higher risk zip code. With this, frequency of default is increased. In other words, as lines are pulled and borrowing capacity is reduced, paying borrowers are pushed into vulnerable financial positions along with nonpaying borrowers, and therefore a greater number of defaults in fact occur.

The spiral effect causes additional harm, even to great customers

…credit-card lenders are currently playing a game of “hot potato,” in which no one wants to be the last one holding an open credit-card line to an individual or business…Thus, as lines are cut, risk exposure increases to the remaining lender with the biggest line outstanding

The author also discusses ensuing changes to law that will also further regulate and potentially damage a lenders willingness to lend.  Check out the info in the article and elsewhere regarding UDAP and other issues of law regarding the credit markets.

Trying times for even the most responsible consumers.  Good thing there are options and protections!!