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There is another problem: credit reports are often inaccurate. A study by the U.S. Public Interest Research Group concluded that 1 in 4 reports had serious errors. A 2009 Smart Money investigation headlined "Why Credit Bureaus Can't Get It Right" found that when consumers complain to credit bureaus about inaccuracies, they could often expect only 50 cents' worth of effort done by employees of offshore contractors to fix the problem.
Combined with the fact that many people do not even know what is in their credit report, errors of this sort can mean that job applicants are being denied jobs for things they did not do — and they may never find out about it.
Making matters worse, the use of credit checks falls disproportionately on black and Hispanic workers — the ethnic groups that happen to have among the highest unemployment rates. One study by Freddie Mac found that 48% of blacks and 34% of Hispanics have "bad" credit records, compared with just 27% of whites. Not surprisingly, people with low incomes have worse credit ratings than people with moderate or high incomes.
The racial differential can mean that the use of credit histories in hiring violates federal civil rights law. The EEOC has taken the position that the use of credit histories in employment is illegal discrimination. Last December it sued Kaplan Higher Education Corporation, charging that its use of pre-employment credit checks discriminates against black job applicants. At the time, Kaplan denied any discrimination and said it conducted background checks on all prospective employees; "We are an equal-opportunity employer, and we are proud of the diversity of our workforce," it said in a statement.
Even before California acted, momentum was growing at the state level to rein in the use of credit reports. In the past few years, Hawaii, Illinois, Washington and Oregon put limits on pre-employment credit checks; most recently, Maryland adopted a law in April, and Connecticut did in July. These state laws contain exceptions — they may not apply to certain kinds of companies, like banks, or when an employer can show that the credit check is legitimately job-related.
More than a dozen additional states are considering limits on the use of pre-employment credit checks. And it is likely that even more will be adopted. One of the many ways the Great Recession is affecting the U.S. is that it is expanding the number of people with bad credit — and, in the process, actually taking away some of the stigma. In these hard times, an increasing number of voters are likely to identify more with the struggling job applicant than the credit-checking employer.
Cohen, a former TIME writer and former member of the New York Times editorial board, is a lawyer who teaches at Yale Law School. Case Study, his legal column for TIME.com, appears every Monday. You can continue the discussion on TIME's Facebook page and on Twitter at @TIME.