If you have bad credit, good luck finding a job. According to a 2012 survey, 47 percent of employers said they run credit checks on applicants. Many hiring managers believe that a troubled financial history signals untrustworthiness, or a defective work ethic, so they weed out job-seekers with stains on their credit reports.
This probably doesn't make sense. Studies find little evidence that possessing a clean financial record has anything to do being a good worker. Medical debt, not credit card debt, is the top reason that people file for bankruptcy. When employers regularly reject applicants bearing the scars of financial distress, poverty becomes an airtight trap.
For these reasons, one of the hottest ideas among lawmakers right now is to ban employers from running credit checks on job applicants. Since 2007, eleven states, as well as Chicago and New York City, have passed such laws.
Supporters of these restrictions often frame the issue as a civil rights problem. In particular, they say, credit checks impede employment among minorities, who disproportionately have low credit scores.
When employers screen for credit histories, "it locks people out of jobs in ways that simply make no sense," New York City Council Member Brad Lander, the main sponsor of the city’s measure, said in April. "In the big picture, that also adds up to discrimination against communities of color and low income people."
But a new study from Robert Clifford, an economist at the Boston Fed, and Daniel Shoag, an assistant professor at Harvard’s Kennedy School, finds that when employers are prohibited from looking into people’s financial history, something perverse happens: African-Americans become more likely to be unemployed relative to others.
There were always going to be winners and losers from these bans, Shoag says. That’s because these kinds of regulations don’t really create new jobs. They help some people to get hired at the expense of others. “Even the strongest proponents of the bans, I think, didn’t expect employment to increase overall,” Shoag says. “There was going to be some redistribution of jobs.”
What’s surprising is how that redistribution happened. In states that passed credit-check bans, it became easier for people with bad credit histories to compete for employment. But disproportionately, they seem to have elbowed aside black job-seekers.
The people who benefitted from credit check bans
Clifford and Shoag found that when a state passed a credit-check ban, employment went up by about 2 to 3 percent in neighborhoods with low average credit scores (below 620). This is all relatively speaking — for comparison, and to rule out coincidences, the economists also looked at states that didn’t have credit-check bans, and neighborhoods with high credit scores.
While neighborhoods with bad credit benefited from the new laws, neighborhoods with slightly higher credit scores suffered. This chart illustrates how jobs shifted around after credit-check bans took effect.Neighborhoods with average credit scores between 575-600, for instance, saw employment increase by 5 percent increase compared to neighborhoods with average credit scores over 670. But neighborhoods with average credit scores between 640-650 saw employment fall about 3 percent.
The researchers also found that when a state passed a credit-check ban, it attracted workers from other states — particularly out-of-state workers from neighborhoods where people had bad credit on average. This is further evidence that these laws did what they were expected to do. They made it more likely for people with bad credit to find employment.
These were good jobs too. The laws had the strongest effect on those who were seeking positions paying upwards of $40,000 a year. The results suggest that credit checks were mostly keeping people out of higher-paying jobs. When states outlawed employer credit checks, applicants with bad credit had a better shot at reaching the middle class.
Why did black unemployment go up?
To understand how banning credit checks can lead to unforeseen repercussions, consider the problem from the employer’s perspective. A single job opening these days can get hundreds of applications. Since hiring managers can’t interview every candidate, they need some way to narrow the field. Filtering out people with bad credit helps them bring the number of applicants down to a manageable size. But if employers can’t look into a job-seeker’s financial history, they try something else.
“Employers have many screening measures to narrow down who they want to hire,” Shoag says. “If you take one away, they'll put more weight on the others.”
That’s exactly what seemed to happen in places that outlawed employer credit checks. Looking at 74 million job listings between 2007 and 2013, Clifford and Shoag found that employers started to become pickier, especially in cities where there were a lot of workers with low credit scores. If a credit-check ban went into effect, job postings were more likely to ask for a bachelor’s degree, and to require additional years of experience.
There are other ways that employers could have also become more discerning, Shoag says. They might have started to rely on referrals or recommendations to make sure that applicants were high-quality. In the absence of credit information to establish trustworthiness, they may even have fallen back on racial stereotypes to screen candidates. The researchers couldn’t measure these tactics, but they’re possibilities.
Any of these reasons might explain one of the study’s strangest findings. In states that passed a credit-check ban, unemployment for African-Americans rose by about one percent compared to unemployment in other states and among other demographic groups. This remained true after controlling for factors like education, age, and gender.
Why were African-Americans put at a disadvantage when states banned employer credit checks? It could be that black job-seekers found it harder to meet the increased education and experience requirements that employers started to impose. Or it could be that employers simply started to become tougher on black applicants because they couldn’t verify their credit histories and assumed the worst.
A powerful study published last year in the Review of Economics and Statistics shows something of the opposite happening: When employers began to require drug tests for job applicants, they started hiring more African-Americans.
“The likely explanation for these findings is that prior to drug testing, employers overestimated African-Americans' drug use relative to whites,” the study’s author explained in an op-ed. Drug tests allowed black job applicants to disprove the incorrect perception that they were addicts.
It’s possible that credit checks were playing a similar role to drug tests, offering a counterbalance to inherent biases or assumptions about black job-seekers. In the absence of that information, employers had to rely more on other clues about the quality of applicants, including their education and experience levels, but also, perhaps, their interview skills or their recommendations. Whatever the new criteria were, they seem to have put black applicants at a disadvantage.
“This reflects a general movement of legislators monkeying around with the hiring process without thinking about the consequences,” Shoag says. It makes sense that employers should not discriminate against people for past financial misfortunes. But we should also be suspicious of laws that increase racial disparities.
Is the world fairer, now that 11 states prohibit employers from running credit checks on job applicants? According to Clifford and Shoag’s research, the answer is hard to say.
