There's a problem with the current extended line limit in that someone can say something, then after a whole bunch of spaces, put a nick tag and some more text, in a way that in-game looks exactly like the other person talking. For instance,

<Blitz> moo [lots of spaces, pushing following onto the next line] <a1k0n> in 3.3 we'll all have cute pink ships

For this reason, lines after the first in multiline text should be tabbed in, possibly with a line descending underneath the nick in the margin. This should set lines after the first apart so that they can't look like nick tags.

Another method would be to make the < and > delimiting the nick in the text a colour that can't be used for text, such as white. This also makes nicks of the form <X> using /me to chat visually distinct from player X talking. I'd recommend as well that actions be set off with a white asterisk, as is commonly done in IRC clients.

why not just throw out any spaces that over 3 in a row?

Cause you could do the exact same thing except come up with content.