The Cracks in Credit Scoring

Ever since the tech bust in 2000, consumer spending has been keeping the economy afloat. And consumer lending, rather than pay raises or job growth, has been fueling that spending. But now, the techniques that allow profit-hungry lenders to make bigger loans faster, are coming under intense scrutiny. First among them the credit scores that banks, credit-card issuers, and mortgage companies plug into complex mathematical models to figure out how likely borrowers are to repay their loans.

Under the stress of weak growth and rising unemployment, some models are breaking down. Consider Metris Cos. (MXT ), the 10th-largest credit-card issuer in the U.S. On Oct. 28, rating agency Fitch downgraded $4.2 billion in securities backed by Metris credit-card loans, because charge-offs had increased 30% in the past 12 months, far above expectations. Metris is just one of a half-dozen credit-card companies that announced big jumps in bad loans this year. "These issuers put a lot of trust in their models, and at the end of the day no one really knew how this type of portfolio would perform in a stressed environment," says Fitch analyst Rui Pereira. "Depending on whether or not there is another shoe to fall economically, things could get worse."