Thursday, February 25, 2010

Is Prohibiting Potential Employers from Using Credit Checks a Good Idea?

Oregon state Senate Bill 1045 prohibits most employers from using credit checks in their pre-employment screen of job seekers.  It has passed the house and senate and awaits the Governor's signature.

It is not clear to me where the market failure is here.  It seems to me that proponents of the bill are suggesting two problems: the information is not meaningful (good people caught due to no fault of their own), or the information is wrong.  If the information is not meaningful or inaccurate then the market should take care of the problem by itself: employers will find that using credit reports does not yield good information and costs money and time and thus they should decide that it is not worth the effort.

So if the argument that the credit score has nothing to do with whether a person will be a good employee is true then the worth of credit scores to employers should quickly be revealed to be nil and they will stop on their own.  In which case there is no need for a legislative solution.

Now there is one way in which I can see a problem that may need a legislative solution: if the information is wrong but not randomly wrong, systematically wrong.  In other words if one group's credit scores are systematically lower due to error. For instance if racial minorities are more likely to have mistakes on their credit reports which lowers their scores.  In this case using a credit score is equivalent to discrimination (albeit unwittingly).  If this is true, however, the problem is with the credit rating agencies themselves and has many more implications than just hiring.  The solution to this problem is regulating the agencies themselves. [Note: a quick search of the literature revealed no study claiming bias in the scores themselves though the scores themselves may be indicative of discrimination - e.g. giving minority applicants access only to sub-prime loans even if they qualify for better. But also note that if using biased scores leads to discrimination on the basis of sex or race then there is already a law that prohibits such behavior - for any reason]

Employers base their hiring decisions on many factors that aren't always in our complete control and can be victims of circumstance. A health emergency that may have ruined someone's credit may have also caused some bad grades in college.  But GPA is an acceptable piece of information to use and no one proposes regulating using it.  Smart employers will ask why the GPA is low or the credit is bad before making their decisions, because more information in markets is almost always a good thing. For this reason, I don't think deliberately limiting the information prospective employers can collect is a good idea.

Note: I imagine a large number of my readers will disagree - please do so politely and on the merits of my analysis, but please do comment!  


Mary Sue said...

High student loan debt loads lowers your credit score. Therefore, younger people (and now, we're starting to get older, I'm in my thirties with 50k left to go on my M.Ed.) will tend to have lower scores than older people. Which turns the credit check into age discrimination.

Patrick Emerson said...

But then the credit check is revealing nothing to the potential employer and they are actually hurting themselves by not hiring highly productive employees. This the crux of my argument - if the credit checks are wrong or misleading, the employers themselves will be hurt by using them and acting on them, they will end up with less productive workers and be less competitive. Because this is not in the interest of employers, they should have no interest in using credit checks if the claims are true.

I doubt that the difference between my decent score and someone like me but without my significant educational debt (I am like you) whose score is a bit higher is at all informative to employers and thus I doubt that they make decisions on this basis (besides, they can see the debt on a credit report). I imagine it is only those with very trouble credit histories that raise red flags because this is the only area where any real information is gained.

Jeff Alworth said...

You assume rational actors. (Or perhaps I've wandered inadvertently into jargon.) Let's use a hypothetical. Imagine that an employer were using a test of race rather than credit. You might say, as you have here,

"If the information is not meaningful or inaccurate then the market should take care of the problem by itself: employers will find that using credit reports does not yield good information and costs money and time and thus they should decide that it is not worth the effort."

Well, it's not meaningful to the job but it is meaningful in other ways.

I believe the burden should properly be on those who are asking for the information. What is the information used for? How does it "meaningfully" inform an employer about a candidate's competency?

Clearly, the poor are going to have on average far worse scores. So if you want to defend a proposal that uses a filter that screens them out, I think it's incumbent on you to explain how the filter is necessary. In matters of public policy, we can take other matters into account beyond market efficiencies.

Patrick Emerson said...


I don't follow your argument. First if you use the check as a way to discriminate based on race, there are much easier ways to do so and no matter which method you use it is illegal, so no additional policy is needed.

And why would an employer want to use it as a screen for poverty? Presumably these workers are no less productive, reliable, etc.

The point of my argument is that the only way in which the market supports the expense of a credit check is if, in equilibrium, it is meaningful in terms of real productivity. Why businesses have to defend this practice baffles me? Do they have to justify using education as a qualification or screen?

My opinion in these matters generally, is that it is up to policy makers to identify the problem before introducing a restriction on behavior.

Jessica said...

I don't have strong opinions on this issue one way or the other but I do think that the arguement can be made to use credit checks for employees in certain positions. For instance, I am a CPA and the CFO at a business. I think checking my credit is a reasonable act by my employer because how can I contribute to running a business' finances if I can't run my own personal finances in a prudent, responsible manner.

I also think credit checks might be reasonable for employees dealing with cash or other easily stolen assets. I'd prefer someone in that kind of position who has good credit because I would worry that someone with bad credit has money problems that may provide an extra incentive to steal.

Dann Cutter said...

I think it can be shown that there is a good justification for market interference by the government in this case.

A reasonable argument can be made that the credit report provides valuable information to some (note, not all) employers. I leave this argument for others, but for the sake of 'my' argument, let us assume this to be true. Regardless, at the end, it will matter little either way.

What protection or value is there then with governmental restrictions on usage? Let's examine the biggest and most clear regulation on hiring: discrimination.

Not to argue to any specific discrimination, can we show that discriminating information not normally allowed as part of an interview or employee HR process is contained in a credit report? I think we can, regardless of whether it is used.

Does your credit score given private health information - yes, it absolutely can. It can show a debt to say, OHSU fertility clinic. Or a Rehab facility. Or a psychiatric service. Can it divulge information regarding marital or relationship status? Yes, legal and child support claims can show up. Can it divulge associations? Yes, though more obscurely, it can show debts or services only available to certain religious or associative members.

So, unless declared as a need for a sensitive position, this information indicates information for which job applications frequently contain a statement declaring their illegality of consideration for basing employment decisions. (often called the 'equal opportunity statement')

So where is the market failure here: Simply that though prescribed as illegal in terms of discriminatory content, this information clearly does have informative value and is being used, likely contrary to existing law. While in a perfect world it would not be a matter for consideration, unwritten employment practices may quietly selectively exclude some classes based on this information.

Since you cannot ask it directly in many cases, you should not be able to circumvent that by acquiring the information via other means. Yet employers do.

Employers who are doing their due diligence within the law should not have difficulty with this restriction - and in fact, business who can show a 'bona fide occupational qualification' have an exemption, which shows that opposition requires that a business state that they DON'T have a reason to require the info (of which, according to economic theory, there should exist no such business) or they desire to use the information in an improper way. Since many businesses have decried to be no longer able to run these checks after the legislation, we can reasonably conclude that many were doing so for either, perhaps, unintentionally unlawful or more likely, economically foolish reasons.

Thus, governmental intervention serves only to restrict those seeking information that they do not need. Since there is a 'loss' inherent in a certain number of these reports being lost or stolen from these misguided employers, this intervention reduces that economic loss, which serves as a valuable externality for all involved.

Jeff Alworth said...

Patrick, maybe I wasn't clear. My point was, you suggested that the only reason an employer would run a credit check only if it was "meaningful." My hypothetical was that an employer might use some other criteria besides economics to determine "meaningful." As some commenters have pointed out, there may be meaningful reasons in some jobs.

But, given that the poor will disproportionately have bad credit ratings, I want to know: of what value is it? Are employers using it as a proxy for trustworthiness? Honesty?

I used race because this was one area in which a lot of law was constructed to stack the deck against non-whites. I worry that we allow the same thing to happen against the poor, keeping them in a cycle of poverty. I don't trust the motives of employers on this one. So why not pass the law?

Jeff Alworth said...

Dann just beat me to the post. Had I seen his before mine went up, I would have just said, "what he said."

Patrick Emerson said...


This potential privacy issue is one I hadn't thought of and is a much better rationale than legislators have been promoting. I wonder why not?

It is particularly interesting because (at least for us) there are a whole host of questions we are not supposed to ask potential hires - mostly stuff about family background, marital status, etc. Though from what I understand about labor law there is a very narrowly defined 'protected class' of individuals for which you can legally sue for discrimination.

I'll make one final note as I leave to ponder this further. But you seem to be arguing that the information can be used to facilitate discrimination. I agree completely that discrimination is wrong and should be stopped. But just because something could possibly be used to discriminate doesn't mean we should ban it - that is a pretty slippery slope. I could use my phone to harass people, but I don't and I don't think you should take away my phone because the possibility exists.

That said, I am sympathetic to your point, and I shall gather my thoughts...

Dylan said...

Hi Patrick,

I'm probably using the wrong jargon in my post, but I think that you are incorrect in assuming that the market participants (hiring firms) are rational in their decision-making about hiring.

As an example, I know an of extremely successful investment banker that was not hired by the big firms back in the early 1960s when he left law school because he is Jewish.

He would have made those firms a lot of money, but they didn't hire them because he was a Jew.

This analysis would also hold up for say an African-American in the 1930s. An African-American with an engineering degree and a 4.0 GPA from a northern university would have been unhireable in the deep South, even though she/he could have been a better performer than a white person.

Discrimination occurs because of irrationality. If people were totally rational all of the time, discrimination would evaporate. Since people aren't rational, legislation is required to correct the market's inefficiency.

Since there is discrimination in hiring due to credit scores, it seems that the legislation is necessary because the market isn't being efficient.

M said...


Your analysis assumes that job requirements have got something to do with money management (my credit score). If job requirements have nothing to do with money management, then the credit check amounts to nothing but discrimination. Also many "poor" money managers are victims of circumstances beyond control of the person; for years we struggled after our children had medical issues - high credit cards, because at $1,080 per month for our BXBC insurance premiums, we couldn't afford to go to the doctors or pay for our prescriptions, and we didn't get out from under that rock for years and years (during which period a higher paying job might have helped this "poor" money managing couple).

Poor money managers can be great truckers, teachers, customer services experts, salesmen, firemen, government workers, TV repair guys and so on.

I understand the criminal background check.

In most cases (because the job in consideration has nothing to do with personal money management) the credit check is nothing more than invasive discrimination.

Patrick Emerson said...


This is getting a bit tangential, but discrimination is anything but irrational in economics. If someone is a racist or anti-semite then their utility (satisfaction) is enhanced by bigoted actions. This is not an excuse or a justification, far from it. But it is important to understand that these behaviors, like many others, generally come from standard rational decision making by racist actors. They pay a price for their racism - hiring less able majority race individuals mans they will be less productive as a firm. But this is a price they are willing to pay because they gain utility from acting on their preferences.

It is important to understand because the policy implications are quite different depending on the motivations. In the rational case you can use market based incentives to combat racism, while in the irrational case there is basically nothing you can do except to try and catch it ex post.

But as I said, I don't think credit scores are the most efficient way to figure out someone's race or religion.

Patrick Emerson said...


I don't assume anything at all. I have no idea if the credit scores provide meaningful information about the subsequent job performance of an individual. What I am saying is that if they don't firms will stop using them anyway.

The fact that firms seem to use them, suggests that they have found that there some utility in using them.

Greg Fisher said...

Your discussion is based on a false premise: That employers have legitimate access to credit scores for use in employment screening.

Pierre said...

Thanks for your post with its strong ideas.

"It is not clear to me where the market failure is here. It seems to me that proponents of the bill are suggesting two problems: the information is not meaningful (good people caught due to no fault of their own), or the information is wrong."

I think you're pretty close to being right, except...

Market failure = being obnoxious.

Don't employers have enough power already, that the democractic process can't pare it down with a sense of social politeness?

Proposed: employers adopt the practice of making potential new hires dance like a chicken. Employers would film this and post it on youtube. The market value of this is to test the obedience of the employee, and also test how much they truly want the job.

M said...

Patrick (are you the blogger, by the way? I'm new here)

Employers find utility in knowing about credit status of an employee, in that it provides employers with the basis to halt the progress of those who need the most help. It is a "keep down the down" system.

I do not deny that they like the "utility" (of playing God this way).

I just happen to think it is wrong to do this.

In 2008 I represented a City in its application for direct access to the Federal Reserve upon demonstrable exigent circumstances. Specifically, 17 banks had refused to conduit US dollar denominated assets to the Treasury for a reverse repurchase transaction ("repo"), and only banks, brokers and federal programs have access to the fed res via GLBA. The banks refused to perform the loans because the facilities to be thus financed were new, and had no credit rating, ignoring the fact that the municipal utility engaged in the developmental agreement was 50 plus years old and had receipts that old. The Banks utilized their discretion to refuse to price the assets and refuse to conduit the assets, knowing that the US instruments were to be "haircut'd" to some 85% and that there is no possibility that dollar denominated instruments would not shift with the value of the dollar (perfect parity). In any case, the exigent circumstances were denied BUT shortly thereafter (upon later visits to Washington) the banks could defend themselves no further and our credit crisis was acknowledged (we were certainly not the only ones saying they were non-functional).

The "utility" of employers having access to credit scores upon an employment decision which employment in no way requires money management nor employee-access to capital, is the same game that I see my own siblings, who are bank VPs, playing all the time:

you don't have to interact with people if you can call them unworthy.

In a down economy, it is easier to understand who has pockets and who have no nest-eggs, and get the "rich" on your side and make sure those lacking support systems are discriminated against.

(sorry, all that wasn't meant quite so personally as it sounded, it is still a source of personal irritation to me-- this feels like therapy!)

Greg Fisher said...

Portland channel 2, KATU reported that an Oregon citizen "says he can’t get a job because of his credit score."

I wrote to the employer and asked, "Do you use credit scores in employment screening?"

The employer responded, "No we do not."

What indicates that employers use credit scores?

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