A Veneer of Certainty

A reader of the MomsRising post below had asked how an increase to the minimum wage could posibbly cause unemployment, reasoning that a better-paid worker is a happy worker, leading to greater productivity and profit for the employer. That could be true if we only looked at the worker side of the equation, but let’s break it into that old economics standby, the supply/demand graph.

In the panels below, the amount of labor demanded by employers for a particular wage is represented in blue; the supply of labor willing to work for that given wage is shown in pink.

In the first graph, we see the wage equilibrium point, the point where demand for labor balances out with the available supply at a wage level acceptable to both sides.

When a minimum wage is set, it creates a binding price floor for wages. If the minimum wage is below the wage equilibrium point, then there is no effect on supply and demand for labor. However, in the second graph, a wage floor has been instituted that is above the wage equilibrium.

Point A, where the minimum wage crosses the labor demand line, creates a theoretical limit on the amount labor an employer will demand. (“Theoretical”, in that an employer could still hire more workers at the minimum wage rate, but that changes their demand curve.)

At point B, we see that workers will accept higher wages but do not have to accept lower, pretty much negating the lower part of their supply curve. The difference between points A & B is considered labor surplus, or ….unemployment. There is more labor available than employers are willing to pay for.

Not all workers might be affected. Those earning wages significantly higher than the minimum wage typically are not, but workers closer to the minimum usually feel the effects. More often than not, these are lower-skilled, lower-paid workers that the minimum wage was intended to help.

The net effect of raising the minimum wage is that while it might improve the wages of labor already in the workforce, and also raising the cost of labor for employers, it creates a barrier to entry of new workers who might have otherwise accepted wages lower than the minimum. These potential new workers, combined with workers who may have lost their jobs due to the increased cost of labor, are the unemployment that we’re concerned with.

A reader of the MomsRising post below had asked how an increase to the minimum wage could posibbly cause unemployment, reasoning that a better-paid worker is a happy worker, leading to greater productivity and profit for the employer. That could be true if we only looked at the worker side of the equation, but let’s break it into that old economics standby, the supply/demand graph.

In the panels below, the amount of labor demanded by employers for a particular wage is represented in blue; the supply of labor willing to work for that given wage is shown in pink.

In the first graph, we see the wage equilibrium point, the point where demand for labor balances out with the available supply at a wage level acceptable to both sides.

When a minimum wage is set, it creates a binding price floor for wages. If the minimum wage is below the wage equilibrium point, then there is no effect on supply and demand for labor. However, in the second graph, a wage floor has been instituted that is above the wage equilibrium.

Point A, where the minimum wage crosses the labor demand line, creates a theoretical limit on the amount labor an employer will demand. (“Theoretical”, in that an employer could still hire more workers at the minimum wage rate, but that changes their demand curve.)

At point B, we see that workers will accept higher wages but do not have to accept lower, pretty much negating the lower part of their supply curve. The difference between points A & B is considered labor surplus, or ….unemployment. There is more labor available than employers are willing to pay for.

Not all workers might be affected. Those earning wages significantly higher than the minimum wage typically are not, but workers closer to the minimum usually feel the effects. More often than not, these are lower-skilled, lower-paid workers that the minimum wage was intended to help.

The net effect of raising the minimum wage is that while it might improve the wages of labor already in the workforce, and also raising the cost of labor for employers, it creates a barrier to entry of new workers who might have otherwise accepted wages lower than the minimum. These potential new workers, combined with workers who may have lost their jobs due to the increased cost of labor, are the unemployment that we’re concerned with.

Long ago, in a neighborhood far far away, I asked my mom for a loan of a couple bucks so I could buy a balsa plane (with rubber-band, windup propeller!). I promised to pay her back via various extra chores, but for one reason or another those additional duties just never got done. Oh well. Now, she may have assumed that it was unrealistic that I would pay her back but she forked over the cash just the same.

Now there’s governmental talk of a bailout for subprime lenders and borrowers. This seems like a very bad idea for at least a couple of reasons.

Lenders knew (or should have known) the risks inherent in loaning money to people with “less than perfect” credit histories/ratings. In some cases funds were provided even without verified income. They took that risk because a combination of high rate of return and a record-low cost of credit. A bailout for the subprime lenders is tantamount to government subsidy of bad investment moves. In addition, the securitizing and sale of packages of these high-risk loans only served to create a financial instrument to pass on the risk. Should purchasers of these securities get a bailout? Of course not. They should have known what *they* were doing, too.

The faults borne by subprime borrowers are, I think, a mixed bag. Certainly some were dazzled by promises of home ownership beyond their expectations. But therein lies the rub: how much home did they reasonably expect they could afford? I believe part of this is due to the very low value our society places on good fiscal stewardship. We’re more focused on material gain with little to no thought as to financial discipline. A few years ago when easily-available credit cards rained down from above, a goodly number of people went out and charged themselves into receivership, without thinking about the inevitable bill. For the government to now provide a safety net for borrowers’ poor fiscal planning will only create an incentive for those borrowers to default on their already shaky debt.

My $.02: Let the subprime mess fall down. In the long run we'll hopefully learn something from the ugly shakeout and be better stewards of money.

A bit of followup from my previous post on the possibility of subprime bailout.

Several states are looking into bailout hybrid arrangements involving private sector refinancing of subprime mortgages in – or due to – default, backed by bond issues. The Maryland program provides a state-brokered refinancing via commercial lenders, targeted to lower income borrowers, where…

[a]fter the approved private lender puts together the new loan, it bundles it with others and sells them to the agency, which uses cash from a bond issue to buy the bundled loans.
The goal is that state coffers would not be used - the state hopes to pay off those bonds with the interest it collects from borrowers.

Federally, Freddie Mac will be implementing its own program to facilitate refinancing for subprime borrowers. Some smart & responsible features of the plan are the tightening of borrower’s documentation requirements and the requirement of lenders to qualify at a fully-amortized rate, restricting the influx of further risky debt. The odd part is that Freddie Mac is one of the repackagers/issuers of mortgage-backed securities, which in my estimation is part of the subprime problem.

Helping borrowers avoid default can be a very good thing, especially with some fiscal discipline learned along the way. The political cost should states be forced to cover defaulted refinance… that’s a good question. Time will tell.

Good overview here on the role of lenders in the subprime mortgage mess, with emphasis on the securitization of risky lending. The ugly end truth is in there...

Whether or not big investors come out okay, the damage is done for many homeowners. "The system allowed banks to create unsustainable loans that are going to haunt borrowers for years to come," says Allen Fishbein, director of credit and housing policy at the Consumer Federation of America. "Unlike the bank, the borrower has no way to lay off the risk."

Given the reluctance of any Congress to own up to pork spending, I'm really starting to become a believer of one of Steven Landsburg's ideas from "More Sex is Safer Sex". Specifically, the chapter that suggests the federal taxation rate of congressional district should be tied to the spending initiated or approved by the district representative. Higher taxes for the people who elected the rep who voted for it. The reps - and their constituents - would get the message real quick that there is an incentive not to play fast and loose with the Big Bucket of Cash.

Landsburg's point, among others, is that voters need to be better informed about how federal revenues are spent with regard to taxes. A fantastic idea when coupled with increased accountability from our elected representatives.

There is a nice writeup at CNN-Money.com that lays out a proposed blame schedule for the subprime mortgage debacle. On the surface it seems pretty accurate, given the available data so far, but I find it difficult to get behind a couple of their assumptions.

Wall Street's eagerness to bundle & securitize the subprime loans, while probably not as transparent as investors would have liked, was a fine way to spread risk. The Street is always looking for new instruments and collateralized debt obligations were the flavor du jour.

The article lays the Fed blame at the feet of Greenspan who used housing as a major monetary prop after 9/11. It's always dicey to focus on a single sector but it seems like it was a Hobson's Choice for Greenspan since housing-related sectors comprise about 40% of the GDP my guess is he was looking for the biggest bang for the buck.

Personally, I'm castigating the brokers, lenders and borrowers who, knowingly or not, were playing a fast and loose game with easy credit.

Now that subprime is shaking itself out, I'm curious as to whether another credit problem is showing up: student loans. I see these TV spots for easy student credit and can't help but wonder if that's the next big bite and how much these private lenders are regulated. I worry that lenders are using the fears of rising costs of a college education to draw in desperate borrowers.

Much like the recent hue and cry for assistance for those with subprime mortgage woes, I can't help but wonder if much of the market volatility of late has been contrived to pressure the Federal Reserve into reducing interest rates even further. A threat, if you will, to hold the economy hostage until the Fed relents and provides an indirect bailout via fluid credit.

And where were the risk management departments when CDO's packed with subprimes were going around? For several years we've been hearing about the vaunted risk management strategies employed by some of the largest financial institutions. It even became a career path, for 's sake. Were they looking the wrong way when hedging?

Either way, it's called "risk" for a reason. Mitigate it via legal & ethical means, not an indirect bailout.