Credit check bans could increase racial disparities

When it became too legally dicey for employers to provide honest references to would-be employers of their previous employees, employers turned to companies that run background checks instead.

The odds are better than even that, the next time you’re up for a new job, someone will look at your credit history, MPR News reported a few years ago.

But more often now, some states are asking “what does your credit score have to do with whether you’re any good at the job for which you’re applying?”

The Washington Post’s Wonkblog reports today on a study that says credit checks keep people out of higher-paying jobs. And in states that have outlawed them, applicants with bad credit had a shot at reaching the middle class.

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.

The theory in banning credit checks was that lower-income job applicants — African-Americans in many cases — would benefit. But the opposite happened. In states that banned credit checks, unemployment for African-Americans went up.

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.

Wonkblog points to a study from Notre Dame in theorizing that when employers aren’t able to use data, negative stereotypes dictate hiring decisions.

That research found that when employers used drug testing, African-American employment went up, according to Abigail Wozniak, an economist at Notre Dame.

The likely explanation for these findings is that prior to drug testing, employers overestimated African-Americans’ drug use relative to whites.

Employers do care about the results of the tests: I also find that employment in high-testing industries increases among self-reported non-users after a pro-testing law is introduced. Drug testing therefore appears to detect a characteristic that employers value but which they had a difficult time analyzing – even at the population level – prior to the availability of testing.

This is consistent with some evidence that testing for drug use without using physical specimens is typically inaccurate. By enabling non-drug-using African-Americans to prove their status to employers, drug testing improved hiring of African-Americans in the testing sector.

“It makes sense that employers should not discriminate against people for past financial misfortunes,” reporter Jeff Guo says on Wonkblog. “But we should also be suspicious of laws that increase racial disparities.”

(h/t: David Brauer)