Two economists at the Federal Reserve Bank of New York have come up with a comforting theory for bankers: Don't blame credit card issuers for rising chargeoff rates-blame consumers' widening need for credit.

In the March edition of the New York Fed's monthly magazine, Current Issues, Donald P. Morgan and Ian Toll drew distinctions between "supply side" explanations for high chargeoffs (that lenders are supplying cards to riskier borrowers without raising rates to compensate) and "demand side" explanations (that consumers have been driving up debt burdens on their own).

In this interview Mr. Morgan further discusses the "demand side" conclusion.

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Since your article appeared, have you learned anything new?

We updated some of the numbers. Credit card loans on the books of banks dropped pretty dramatically in the first quarter of 1997. That could be partially a seasonal effect, of borrowers just repaying their balances after the holiday season, but it could also reflect that banks are tightening on their consumer lending.

Whatever the reason, that reduces the denominator in the calculation of the chargeoff rate. So there was a spike I found in the first quarter of '97, and that could be partly due to the drop in the loans off the books.

Your thesis would seem to leave card issuers off the hook-the high chargeoffs aren't their fault. Am I reading you correctly?

Right. It seems that when the news stories began breaking about the rise of chargeoff rates, people seemed to notice that they had been getting a lot more offers in the mail and concluded that lenders were just rushing into the market and overburdening borrowers. That's what we called the "supply side" story-just lenders gambling on riskier and riskier borrowers.

My co-author and I found that story pretty easy to identify with. We had been getting all these offers ourselves. But we tried to sharpen the issue a little bit by saying, "Well, they may be lending to riskier and more indebted borrowers, but the key question is whether they are aware of the risks and whether they are charging higher rates to compensate."

That's what we call the supply shift, the idea that they are lending to riskier borrowers without raising rates.

We looked in some obvious places to find evidence of that. We looked at credit card spreads to see if they had fallen, and we found that in the last 15 years, the spreads had actually risen. In fact, they seemed to be just tracking the rise in chargeoffs. So we concluded that although lenders might have been granting cards to more marginal borrowers, they seemed to be identifying that these were more marginal borrowers and charging higher rates to cover their bets.

Yet issuers are still being criticized as irresponsible.

That's the flavor you sometimes get from the press. There is a sense of, "O.K., this is the comeuppance for this crazy lending." We reacted to that. We study banks here, and I tend to give bankers and lenders in general some credit for being pretty savvy about their business.

We would have been pretty surprised if it was just a fools-rush-in kind of effect. We found that chargeoffs in other types of lending had risen just as much, suggesting that it was some other force driving chargeoffs.

Credit card offers seem so pervasive. How are lenders being savvy?

It's true-they're setting up booths in Yankee Stadium and everywhere else to offer these cards. But one thing I find really fascinating is that lenders now have more sophisticated lending technology, namely credit scoring.

If you can now identify and quantify risks more accurately, then you can expand the credit markets. You can bring borrowers into the market who normally would have been rationed or excluded. You acknowledge, "Look, you are a risky borrower, we're going to have to charge you a hefty rate to cover our risk, but at least now we know roughly how risky you are, and we know what rate to charge."

That's what we were getting at about being able to slice and price the market more accurately. The key operative word there is "price"-they are pricing the risk, or that is what we concluded. The tone of the article is to try to give a little more credit to bankers.

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