Economists often claim that they would be glad to help poorer families, but that such efforts would either be a waste or would actually make things worse. In the area of credit regulation, for example, the constant pitch from some academics (and echoed by the banking lobbyists) is that any limits regulating credit cards will result in driving the country’s most vulnerable citizens to far more dangerous lenders. The theory, called the substitution hypothesis, has been in vogue for two decades, providing intellectual cover for lobbyists’ efforts to checkmate any serious legislative effort to rein in predatory lending practices.
The theory sounds plausible, but a little evidence is an amazing thing. Researcher Angela Littwn has a terrific new piece directly challenging the conventional wisdom regarding the substitution hypothesis. She shows, for example, that those without credit cards simply have less total debt than those with credit cards — not that they take on “worse” forms of credit if they don’t use credit cards. But the really unexpected zinger in Angie’s paper is that, according to the low-income families she studied, there were no credit options worse than credit cards. In other words, these struggling families think credit cards are as bad as it gets.
Options like pawn shops and rent-to-own, which sound terrible to my middle-class ears, were rated on par with credit cards. Direct borrowing from retailers was rated much higher. According to the actual experiences of the people who lived with such credit, credit cards got low ratings because they were seen as much more dangerous (no real limits, escalating interest rates, hidden fees) than pawn shops and rent-to-own stores. To be fair, Angie’s study came from residents of a state that has outlawed payday lending, so there still might be a lower-than-low rating if the payday folks had been in the mix.
If the substitution hypothesis is wrong, and if the main response to limits on credit is that people wouldn’t have so much debt, then what happens in a true emergency? Angie asked these low-income families what they have done or would do if they didn’t have access to credit cards or payday lenders and they really, really needed money? The families in the study gave a resourceful answer: borrow from friends and family. In fact, respondents gave the friends-and-family approach a high rating as a source of credit. Low cost, low risk, but enough interpersonal pain to make them not to use it unless the need was high.
Angie’s study has a small N (these are very expensive data to gather), and, as noted, it is limited to a state with no payday lending, so she is quite careful to call her findings “preliminary.” But her work has broken open some new lines of inquiry. Could some kinds of restrictions work? The automatic no was based on a substitution hypothesis that may not be accurate. Perhaps it is time to do some new thinking–and some more research.
