Testing the Substitution Hypothesis: Would Credit Card Regulation Force Low-Income Borrowers Into Less Desirable Lending Alternatives?

One of the strongest arguments against regulating credit cards is the substitution hypothesis, which states that if a restriction on one form of credit decreases access, borrowers will respond by using other, less desirable forms of credit. For low-income consumers, the argument is more powerful still, because their other options are high-cost lenders such as pawn shops and rent-to-own stores. But the substitution hypothesis has been more frequently assumed than investigated, and the empirical research that has taken place does not support the theory as strongly as has been supposed. The theory is based on a naive presumption about the constancy of demand for consumer credit and a failure to account for a more nuanced view of the role of credit supply. This Article presents original data from a study of low-income women. The findings suggest that lenders such as pawn shops and rent-to-own stores may function as complements more than substitutes. In addition, the research uncovered another form of credit that low-income families routinely use and participants evaluated favorably, but that has never been discussed in the academic literature. These findings suggest a more nuanced formulation of the hypothesis that better predicts the consequences of credit card regulation.