When I started at my current (also first post-college) job, I was a contractor for about 8 months before becoming a regular employee. Two of my coworkers have made the same contractor->FTE transition. When I started it was explicitly a contract-to-hire position... for whatever reason we apparently don't do that any more, although our latest full-time position was first offered to some of the current contractors before our boss started giving us resumes to look at.

I could definitely see this reducing the applicant pool, although a surprising number of people have been looking for hotels on their first day, and then live here during the week and drive several hours home on the weekends.