One of the worst kept secrets in the economy has been that consumer credit is overdue for it’s own subprime meltdown. After years of cheap credit that fueled a boom in consumer spending, credit card companies and retailers providing credit to customers are seeing a spike in defaults. They’re reacting by pulling back on available credit and raising rates, making consumers less able to pay bills by moving balances to the next card.



And, of course, you can’t use your house as the last line of credit defense anymore now that banks have pulled back on home equity lines of credit. You already know how this story plays out: higher default rates encourage tightened credit conditions which raise defaults and diminishes consumer spending, which in turn leads to layoffs, higher defaults, tighter credit, and so on and so on. Retail credit has driven itself right off the cliff, just like housing credit.

Eric Dash at the New York Times lays out the frightening scenario:

The pullback is affecting even creditworthy consumers and threatens an already beleaguered banking industry with another wave of heavy losses after an era in which it reaped near record gains from the business of easy credit that it helped create.

Lenders wrote off an estimated $21 billion in bad credit card loans in the first half of 2008 as more borrowers defaulted on their payments. With companies laying off tens of thousands of workers, the industry stands to lose at least another $55 billion over the next year and a half, analysts say. Currently, the total losses amount to 5.5 percent of credit card debt outstanding, and could surpass the 7.9 percent level reached after the technology bubble burst in 2001.

“If unemployment continues to increase, credit card net charge-offs could exceed historical norms,” Gary L. Crittenden, Citigroup’s chief financial officer, said.

Faced with sobering conditions, companies that issue MasterCard, Visa and other cards are rushing to stanch the bleeding, even as options once easily tapped by borrowers to pay off credit card obligations, like home equity lines or the ability to transfer balances to a new card, dry up.

Big lenders — like American Express, Bank of America, Citigroup and even the retailer Target — have begun tightening standards for applicants and are culling their portfolios of the riskiest customers. Capital One, another big issuer, for example, has aggressively shut down inactive accounts and reduced customer credit lines by 4.5 percent in the second quarter from the previous period, according to regulatory filings.