By Jyoti Madhusoodanan
The 2008 financial crisis upended the business world. But it also rocked the lives of average citizens. In its aftermath, crashing home prices and long-term unemployment led more than 1.5 million Americans to declare personal bankruptcy.
Bankruptcy has immediate, extreme impacts on a person’s creditworthiness, affecting their ability to receive a loan and the amount they can borrow. And beyond home or auto loans and credit cards, a poor credit report can also hinder activities unrelated to credit, such as the ability to rent an apartment. But does it also make it tougher for a person to find a job and recover from their personal financial crisis?
In a study forthcoming in the Journal of Finance, Yale SOM’s Paul Goldsmith-Pinkham, collaborated with Will Dobbie of the Harvard Kennedy School, Neale Mahoney of the University of Chicago, and Jae Song of the Social Security Administration to try to answer that question.
Read the study: “Bad Credit, No Problem? Credit and Labor Market Consequences of Bad Credit Reports”
Existing research hasn’t provided a clear “yes” or “no,” says Goldsmith-Pinkham, an assistant professor of finance. A study in Sweden found that bankruptcy did adversely affect job prospects, but the socioeconomic structure in that country is different from that of the United States, he points out.
Goldsmith-Pinkham wondered about the problem in the U.S context while working at the Federal Reserve Bank of New York. “There was certainly anecdotal evidence that people felt like this was a reason for their dismissal,” he says. “But there’s no clear empirical evidence that someone didn’t get a job simply because they had filed for bankruptcy before.”
Understanding the links between credit and the job market seemed to require a view into an alternate world—to examine the career trajectory of an individual with a bankruptcy flag on their credit report, and then somehow establish how it would have changed if that flag didn’t exist. But Goldsmith-Pinkham and his colleagues found a way to conduct this analysis with real-world data.
In the U.S., individuals can declare bankruptcy in at least two different ways, with different terms of repossession and repayment. Those who file under Chapter 7 must liquidate their property to pay off debts, and the bankruptcy flag remains on their credit report for 10 years. On the other hand, Chapter 13 filers, if they are able to complete a specified payment plan, can have the bankruptcy flag on their credit reports removed after seven years.
The researchers homed in on the three-year period when the flag had been removed for one group but not the other, and tracked credit and labor outcomes for both groups. The team gleaned records of employment and credit from two large databases: one from the Equifax Consumer Credit Panel (CCP), which includes the credit products an individual held, and another created by merging data on individual bankruptcy filings with tax records from the Social Security Administration to track individuals’ employment history. The team found millions of working-age adults who had completed the bankruptcy process, receiving what’s dubbed a “discharge,” in the two databases.
The team found that once discharged, people found it easier to procure loans and credit cards. One year after their bankruptcy flags were removed, 4.6% more Chapter 13 filers had mortgages compared to those who were still under the Chapter 7 bankruptcy flag. Three years down the line, former Chapter 13 filers had higher credit card limits as well as greater amounts of debt.
And what did bankruptcy mean for job prospects? The researchers found that the presence or absence of a bankruptcy flag made little difference to an individual’s odds of employment. It also didn’t help to predict whether or not someone would stay at a job. “It was pretty striking that we didn’t see much effect at all,” Goldsmith-Pinkham says. “It’s provocative because there’s a rich economic literature about signaling—in this instance, the idea that a bad credit report sends some kind of signal about your quality. But that doesn’t seem to be the case here.”
In addition to easing the fears of bankruptcy filers about their job prospects, Goldsmith-Pinkham adds that even a “null result” may have implications for policymakers. In many instances, policymakers must rely on self-reported measures from firms to assess whether they discriminate against groups of workers, such as minorities or women. This study provides one example of how a careful look at the data makes it possible to identify whether hidden biases exist in employment decisions.
“In a lot of work on labor and discrimination, policymakers are forced to rely on self-reported measures from companies that can lead them astray,” Goldsmith-Pinkham says. “You really need this sort of careful experiment to understand the effects.”