According to a recent article in the New York Times, credit card lenders are apparently reducing credit limits in view of increasing concern about credit quality and the potential for accelerating credit card defaults. 

The data cited, however, is ambiguous.  Eight of the major credit card lenders reported a decrease in unused credit card lines from the fourth quarter of 2007 through the first quarter of 2008.  Four of the top credit card lenders reported an increase in unused credit card lines over that period.  The dollar amount for both sets of lenders seems to be roughly equivalent, i.e., the reductions were roughly offset by the increases.  In addition, it is unclear whether the reductions in unused lines resulted from additional borrowing against existing credit card limits or a reduction in credit line limits by lenders…or some combination of the two.  It is unclear, as well, whether the increases in unused lines resulted in net reductions of debt outstanding relative to existing credit card limits or an increase in credit card limits by lenders…or some combination of the two.

The anecdotal evidence argues strongly in favor of restrictive action taken by lenders in those instances in which unused credit card lines declined, thereby adding to the consumer financing dilemma.  The job market continues to soften.  Consumer prices, especially gasoline and food, continue to rise.  Home equity as a borrowing base has virtually disappeared.  Only credit cards remain as a source of financing, but now lenders are tightening credit standards in all areas of activity – including credit card financing – to avoid further losses and further erosions to their capital base.

Michael Taiano, an analyst at Sandler O’Neill, estimates that credit card losses will increase to roughly 10% over the next few months from the present 5.7% level.  If so, the loss level will exceed the level that prevailed after the dot.com bust.  Lenders obviously review and assess the same information as Mr. Taiano, which argues for further tightening of credit availability to the consumer via credit card financing.

Keep in mind that consumer spending drives the economy, since it accounts for approximately 70% of gross domestic product.  Therefore, as the consumer goes – and as consumer financing goes – so goes the economy.

In an interesting initiative, the Comptroller of the Currency, John C. Dugan, recently objected to an agreement reached between the Attorney General of New York, on the one hand, and Fannie Mae and Freddie Mac, on the other. In early March, Fannie Mae and Freddie Mac agreed they would not purchase residential mortgages from lenders who used their own internal appraisal capabilities – rather than those of an outside third party – in establishing market value for the underlying property. The agreement is scheduled to take effect in 2009.

The New York Attorney General maintains that lenders consistently used internal appraisals to inflate property values, which resulted in higher mortgages, greater fees, greater interest income and, in the process, fed the housing bubble and subsequent bust. Independent appraisals, presumably, would be more reliable and less prone to contribute to such market excesses.

Dugan suggested the agreement could lead to unintended consequences but acknowledged, in stating his objections, that appraisals must be conducted free of influence or coercion. He contends that the answer to the problem is better enforcement of underwriting standards for residential loans by the regulatory authorities. The Office of Thrift Supervision joined the Comptroller in raising objections to the agreement.

The appraisal process is the critical analytical process in any residential – or commercial – real estate transaction. It’s the custom of the lending community to outsource this essential piece of the puzzle to independent, outside third parties who possess the skills and expertise to conduct a meaningful appraisal of market value. Yet these independent, outside third parties are hardly free from coercion, influence, or suggestion. In some respects, they may be more subject to such coercion and influence, since they are continuously in the market for repeat business.

The real issue in this controversy is one of assuring quality appraisals. So long as lenders can originate and sell, there is every incentive to use outside sources for the appraisal process, since that avenue is generally less expensive than hiring the professional expertise necessary to conduct appraisals. Regardless of regulatory influence and enforcement attempts, it seems the ultimate traffic cop remains the buyer, not the seller. In other words, only Fannie Mae and Freddie Mac can protect themselves via their own due diligence.