Consumer Credit and the Credit Check Hurdle

Did you see this interesting article in the New York Times last week? Another Hurdle for the Jobless: Credit Inquiries:

…Once reserved for government jobs or payroll positions that could involve significant sums of money, credit checks are now fast, cheap and used for all manner of work. Employers, often winnowing a big pool of job applicants in days of nearly 10 percent unemployment, view the credit check as a valuable tool for assessing someone’s judgment.

But job counselors worry that the practice of shunning those with poor credit may be unfair and trap the unemployed — who may be battling foreclosure, living off credit cards and confronting personal bankruptcy — in a financial death spiral: the worse their debts, the harder it is to get a job to pay them off…

“If I see too many negative things coming up on a credit check, it’s one of those things that raises a flag with me,” said Anita Orozco, director of human resources at Sonneborn, a petrochemical company based in Mahwah, N.J. She added that while bad credit alone would not be a reason to deny someone a job, it might reveal poor judgment.

“If you see a history of bad decision-making, you don’t want that decision-making overflowing into your organization,” she said.

Obviously this could cause a death spiral for unemployed people with bad credit. If your credit is bad because you are unemployed, how will you ever get employed to pull up your credit if these checks become common place? I’m interested in this because it touches upon three additional things I’ve been thinking about lately, points I’m not sure yet where I stand.

Unemployment Signals

Would employers let a job go vacant because an otherwise qualified applicant had a bad credit score? Could this cause underemployment more generally? It’s a common move to think that labor markets will naturally find whoever is talented, and they’ll be smart enough to determine the signal from the noise when it comes to applications. I think the idea of limited bandwidth comes into play with recruitment – if people get screened on noise, the position may stay empty. I hear something similar to this with the debate that jobs that our grandparents used to be able to do with a high school education now require a Master’s degree. People say “well, if people with a high school education were really qualified, the market would be buying them up at a discount” – and the logic is airtight enough, but it feels like something is off.

A request – does anyone know any Stiglitz-like informational papers/models were bad signals cause an equilibrium in unemployment? Behavioral papers – ones where HR reps not at all-knowing demigods but human beings with limited bandwidth?

Personal Information

Setting the appropriate boundaries of access to the large amounts of personal information in the digital database age is going to be a one of the larger issues for us to figure out. A thought experiment: Should your credit score be available on an internet dating website? In addition to “send a message”, or “send a woo”, buttons on the profile you are checking out, should there be a “request credit check ($15.99)” button?

In terms of efficiency, knowing the credit score and all relevant bank and credit accounts of someone you are going to go a third date with strikes me as much more relevant than knowing the credit score for someone you are hiring to do data entry. Yet the idea strikes me, and perhaps you, as an invasion of privacy. Why don’t we feel the same revulsion for the data entry job?

Poor Credit as Strategic Action

Where do the great blog posts go when they die? From 11/08, Chumpchanger on walking away from your mortgage:

In story after story about the foreclosure crisis, you will find the implicit idea that borrowers who can afford to pay their mortgage should keep on paying it no matter how much their house sinks in value because they have made a promise to pay and to do otherwise would be an abuse of the system.

Propagating this idea is good for lenders and probably good for taxpayers, but basically, it’s nonsense…In practice, this means that a bank that doesn’t want to get bogged down in a two year long morass has little option but to take back the keys, accept a huge loss, and call it even. Is this an “abuse” of the system? I don’t see how. The loss was something that lenders could have anticipated at least as easily as borrowers. The reality is that ordinary people are lousy at figuring out the ins and outs of real estate transactions. Relying on the one act rule to get out of a mortgage is not to abuse the system–it is to use the system in precisely the way it was intended to be used. The reason that the one act rule exists is that lenders and developers have through the years shown a great deal of ability to maneuver unsophisticated buyers into crummy real estate deals. The reason that the one act rule exists is to put the risk of these deals on the lender, not the buyer. The purpose is to discourage bad underwriting, dishonest marketing, and unjustified price inflation by making it very, very hard for a lender to get back the money if they lent more on a mortgage than a house was worth. The system is designed to let people walk away. California has a system that puts a higher premium on keeping people out of debt slavery than avoiding bank losses. I see nothing wrong with that legislative choice.

Bankruptcy and poor credit, and in particular the option to go bankrupt or not pay your bills, is a strategic choice to keep the lenders on the other side honest. We think of it in strictly moral terms – people who don’t pay their bills are monsters etc. etc. But the ability to pay a (huge) penalty and walk away from your bills keeps (or should have kept) lenders from following incredibly terrible deals, using dishonest steering techniques, and justifying it with bad underwriting. It’s like normal game theory – if you don’t have the option to defect, you should expect to get rolled pretty hard by the other party. Co-operation is predicated on the idea that we both have the option to harm each other, and it doesn’t need to be acted upon in order for it to keep both parties in line.

In general, the idea that society would fall apart if we didn’t pay our bills sounds right (and comforting, in a way), but really it wouldn’t. The people on the other side of your bill are well aware that you may not pay, and have set up the contract so that you take a big hit too. If you didn’t pay your electric bill, then you don’t have electricity. You may have scammed the electric company for $100, but now you have no power. Same with your phone bill. The electric company is well aware, and has powerful spreadsheets, considering the loss of that $100, and actually it’s already been written up in their losses through probability and expectation calculations.

Yes I know there are people out there who screw up their credit maliciously or accidently. This isn’t a call to arms to not pay your bills – I would say it is a call to arms to lenders and those that extend credit to set up the terms of your contracts to take into account you might not get paid, and get deposits, have markets post collateral, have people ready to threaten a discontinuation of services, etc., but people already do that. Indeed credit card companies are well-known for following the letter of their contracts ruthlessly, and if neoliberalism requires each of us to self-govern as if we were an entrepreneurial firm, there’s every reason for us to do the same.

What happens if poor credit is no longer a negotiation strategy between a creditor and a lender, but instead a more general form of social control?

Comments

[Tom E.:]

FICO is the new big brother. A society of serfs and masters.

"What happens if poor credit is no longer a negotiation strategy between a creditor and a lender, but instead a more general form of social control?"

Aug 12 07:50 AM

[Jason722:]

Interesting, thought-provoking article.

"In terms of efficiency, knowing the credit score and all relevant bank and credit accounts of someone you are going to go a third date with strikes me as much more relevant than knowing the credit score for someone you are hiring to do data entry. Yet the idea strikes me, and perhaps you, as an invasion of privacy. Why don’t we feel the same revulsion for the data entry job?"

My first instinct on this is that the comparison is off. In dating, you might make an emotional investment, but you are not making a significant $ investment (all jokes aside). When a company hires a person, they are committing almost instantly to a sizable investment in salary, benefits, etc. (which would be committed regardless of the person hired) and also in training and continuity (hidden cost of turnover). The latter costs have been shown to significantly affect the efficiency and performance of the human resources division and can impact the company at the bottom line.

So the proper analogy is that of making an investment. Should companies be able to hide their balance sheet from you before you make a monetary investment in them? If not, then why should you be able to hide relevant financial information from a company seeking to make an investment in you. And if you are having financial difficulties, it certainly can affect your performance on the job. I agree with you that this should never be used as a filter (an automated process to weed out applicants), but I don't see companies that use this information in their decision-making processes as doing anything wrong.

Aug 12 08:12 AM

[prudentinve...:]

"In general, the idea that society would fall apart if we didn’t pay our bills sounds right (and comforting, in a way), but really it wouldn’t. The people on the other side of your bill are well aware that you may not pay,....."

I fully agree if we were in a free market where the lender, the lender's investors and management bore the cost of their poor decisions.

However, we live in a system where the lender keeps the profits, but the losses are borne by the rest of society via taxes. Moreover, the lenders now expect that they can perpetuate this practice and profit by originating poor loans in the full expectation that society will bear the losses when they inevitably arise. Additionally, the borrowers have also learnt that they can borrow over their heads and simply walk away leaving the rest of us holding the bag. If this is not a falling apart of economic society, I don't know what is!

Aug 12 08:22 AM

[Sonia:]

In times of slow inflation the lender gets a steady return from interest and the borrower the benefit of ownership and capital appreciation - a good deal for both parties. The congressional mandate that people who could not afford to repay must be allowed to buy caused the bubble - overbuilding, skyrocketing prices, and the inevitable crash. Housing prices will recover over time, and people who can afford their payments would be wise not to walk away and ruin their credit. I don't blame employers for checking out credit scores. If we'd been able to do this back in the 70's and 80's it would have saved us from employing trouble and from renting to deadbeats, with all the resulting problems.

Aug 12 09:38 AM

[Cold Reality:]

The fallacy in your argument is that you assume that the credit report and resulting "score" is accurate. In a very very large number of instances, it is not. The credit reporting agencies do not care whether the reports are accurate or not, and make the process of correcting errors almost insurmountably difficult. In fact, in a perverse way, they seem to resist making a change to a report or score that would improve the report or elevate the score.

I know of an instance recently, where the victim of fraudulent billing had a credit report festooned with errors, spent two years doggedly working to correct have the erroneous information expunged, only to see the credit "score" remain stubbornly at a low value.

Yes, it is an invasion of privacy to use credit scores and spurious credit reports to judge a person to any degree whatsoever. In the current credit reporting and scoring system is so fraught with error and so flawed, that the reports and scores should not be relied upon for anything at all.


On Aug 12 08:12 AM Jason722 wrote:

> Interesting, thought-provoking article.
>
> "In terms of efficiency, knowing the credit score and all relevant
> bank and credit accounts of someone you are going to go a third date
> with strikes me as much more relevant than knowing the credit score
> for someone you are hiring to do data entry. Yet the idea strikes
> me, and perhaps you, as an invasion of privacy. Why don’t we feel
> the same revulsion for the data entry job?"
>
> My first instinct on this is that the comparison is off. In dating,
> you might make an emotional investment, but you are not making a
> significant $ investment (all jokes aside). When a company hires
> a person, they are committing almost instantly to a sizable investment
> in salary, benefits, etc. (which would be committed regardless of
> the person hired) and also in training and continuity (hidden cost
> of turnover). The latter costs have been shown to significantly
> affect the efficiency and performance of the human resources division
> and can impact the company at the bottom line.
>
> So the proper analogy is that of making an investment. Should companies
> be able to hide their balance sheet from you before you make a monetary
> investment in them? If not, then why should you be able to hide
> relevant financial information from a company seeking to make an
> investment in you. And if you are having financial difficulties,
> it certainly can affect your performance on the job. I agree with
> you that this should never be used as a filter (an automated process
> to weed out applicants), but I don't see companies that use this
> information in their decision-making processes as doing anything
> wrong.

Aug 12 05:04 PM

[Old Trader:]

"I hear something similar to this with the debate that jobs that our grandparents used to be able to do with a high school education now require a Master’s degree. People say “well, if people with a high school education were really qualified, the market would be buying them up at a discount” – "

You don't even have to go back as far as "grandparents". Granted, there are jobs for which particular skills/knowledge are needed...always have been, and always will be, but many "entry level" jobs are victims of "diploma/degree inflation". And the funny (ironic, not "ha ha") part, is that from my experience, the average college graduate couldn't construct an intelligent paragraph to save their soul.

It may sound quaint, but there IS something to be said for the "3Rs".

Aug 12 08:29 PM

[Steve in Gr...:]

"...Did you see this interesting article in the New York Times last week?..."

The NYT? God, does anybody read that POS anymore? As they say, there are lies, damn lies and the NYT.

"...Would employers let a job go vacant because an otherwise qualified applicant had a bad credit score? Could this cause underemployment more generally?..."

Can I have some of what you are smoking Mike? I hire people. I try to get the best player available. If I have an open position, the job does not go vacant for long. But I certainly require credit checks and background checks. Neither are dispositive, but both are important data items. It is very difficult to tell based on the interview who is the better candidate. Credit reports are very helpful. If a candidate can’t manage their credit, then they probably can’t manage what I want them to manage.

Personal Information: "... Yet the idea strikes me, and perhaps you, as an invasion of privacy..."

Sorry, but if I am considering hiring a candidate, I have a business reason to look at his credit history. If he can’t manage his credit, that is a very revealing piece of information.

Poor Credit as Strategic Action: "...Bankruptcy and poor credit, and in particular the option to go bankrupt or not pay your bills, is a strategic choice to keep the lenders on the other side honest..."

[Facepalm] People don’t destroy their credit as a way of “sticking it to the man”. People destroy their credit because they are incapable of managing their lives. People incapable of managing their lives might be OK as clerks. But they probably are not capable of managing a business process that I need managed.

Also, those losers who are incapable of managing their credit do not hurt the lenders. They hurt their fellow debtors. Creditors take the losses imposed on them by the losers and distribute them across the other creditors in the form of higher interest rates. Some of these creditors are honest, reliable people. These honest, reliable people pay higher interest rates because the political/legal structure is not sufficiently punitive toward the losers.

Good luck when you meet the real world.

Aug 12 08:48 PM

[ebworthen:]

You are exactly right.

I have students that I can't believe graduated from High School.

I've had co-workers who never graduated High School who could run circles around them.

This is the new aristocracy; buying your way into a job/field with enough connections and money to go to the "right school" and then get the "right job" versus working your way up from the factory floor.

This is a large part of the problem with our corporations and government; many of them haven't done an honest days work in their life and don't understand what real work is.

It didn't end well for the Aristocracy of the European monarchies (except, perhaps, Britain - certainly not France). Let's hope we can return to producing real goods and appreciating individuals for their work ethic and hustle versus degree and pedigree.


On Aug 12 08:29 PM Old Trader wrote:

> "I hear something similar to this with the debate that jobs that
> our grandparents used to be able to do with a high school education
> now require a Master’s degree. People say “well, if people with a
> high school education were really qualified, the market would be
> buying them up at a discount” – "
>
> You don't even have to go back as far as "grandparents". Granted,
> there are jobs for which particular skills/knowledge are needed...always
> have been, and always will be, but many "entry level" jobs are victims
> of "diploma/degree inflation". And the funny (ironic, not "ha ha")
> part, is that from my experience, the average college graduate couldn't
> construct an intelligent paragraph to save their soul.
>
> It may sound quaint, but there IS something to be said for the "3Rs".

Aug 12 09:09 PM

[ebworthen:]

I'd like to see a "credit report" for employers.

Have they robbed the pension fund?

Have they booted employees with spotless records and 10 years of service to hire glassy-eyed 20 somethings who are happy to accept 25K and no benefits?

Was the CEO and/or management team brought up from the ranks or did they bring in outside people to wield the hatchet and torque quarterly profits?

People go through deaths in their families, divorces, sick children, irresponsible spouses, or banks that gamble with their mortgage and get bailed out by the government.

I've seriously considered cashing out the equity in my home and hiding it in gold and becoming a renter and getting every freebee the governemnt doles out after all this bailout crap.

Honestly; what motivation do the responsible have anymore? And how many people will have a "good" credit rating after all the shenanigans and identity theft and unemployment and loss of value in the stock market and companies they believed they were investing in when it was just a ginned up shell game to benefit Hank Fuc*ing Paulson who is living on an island and buying 2% of Bank of America because his boys are in charge on Wall Street?

Honestly.

The American people may act like sheeple sometimes but it is like WWII. We weren't willing to go to war until we were hit from behind, and when that happened the world trembled and Germany and Italy and Japan said "Oh Shit".

This time it is the debasing of the promises made for the past three or more generations.

I do not support my government, and am ready to "prune the tree of liberty."

Aug 12 09:19 PM