Feel the Bern?

Bernie Sanders has a surprising source of support in college students, particularly here at Penn State. I’ve seen dozens of “Bernie 2016” stickers and hear the infamous “Feel the Bern” quite a few times this semester.

Grandfatherly Bernie has, though, received a significant amount of flak for his economic policies. His policies are liberal to the extreme, some might even say socialist. According to Forbes.com, Sanders argued that people “have no disposable income when you make 10, 12 bucks an hour. When we put money into the hands of working people, they’re going to go out and buy goods, they’re going to buy services and they’re going to create jobs in doing that.”

Great in theory, right? Give the uneducated masses more money, and they’ll go spend it on “stuff”. Consumption, in the mind of many, is the key factor that drives economic growth in this country. 70% of our GDP is consumption – many use this fact to argue for higher minimum wages that will spur consumption from the lower classes and drive the economy forward.

However, it isn’t clear that spending by the poor is more beneficial for the economy. In fact, many argue that increased spending from those who would be making the minimum wage is less potent, seeing as they are more likely to buy (often imported) goods rather than services that the wealthy may purchase.

With this contradiction in mind, it’s important to keep the other option for people’s money in mind: saving. For many, the idea that not all of their extra wealth will go straight into consumption affects the actual impact of raising the minimum wage.

In a study conducted by theCongressional Budget Office, it was estimated that the households benefiting most from an increased minimum wage are those above the poverty line, not those below it.

Furthermore, not all of the increased minimum wage is a simple redistribution from the wealthy to the poor. Utilizing a hike in the minimum wage, depending on the elasticity of certain products (how much people’s consumption changes based on prices), the increased wages will often trickle down to the consumers. Higher input costs will lead to higher prices as firms try to maintain solvency – this price hike will come back to bite those who get the higher wages.

One other unforeseen conflict with increasing the minimum wage is the unemployment that it creates. Logically, it makes sense – if firms have to pay more to employ labor, they’ll have to employ less of it.

Courtesy of Forbes

A simple profit maximization condition from all of your thrilling economics classes depends on equalizing the cost of an input and the return it gets you. For labor, hiring too many means cost is above returns, and you’re losing money. Hiring too little leaves returns above cost, and you’re leaving profits uncaptured. Therefore, once we have equality between costs and returns, raising the cost (minimum wage) without increasing the returns (productivity of labor), firms will be forced to lay off employees to maximize their own profits.

Economics lesson aside, there is evidence of increased unemployment following minimum wage increases. Accordingto Professor Stephen Hanke of Johns Hopkins, the average unemployment rate in countries without a minimum wage is nearly 4% lower than in similar neighboring countries that utilize a minimum wage.

Many sources, however, do cede that there is a significant amount of controversy about the topic. Jordan Weissmann, in the Atlantic, does a great job explaining the ins and outs of raising the minimum wage. John Komlos, a professor at the University of Munich, also defends a raise in the minimum wage in a piece published by PBS. Komlos argues that if the minimum wage in 1968 was adjusted for modern prices, it would be almost $11. He cites an Economist report that calculates what minimum wage should be to stay in line with many other developed and successful countries – a number that would make many conservatives faint.

Courtesy of the Economist

Based on US GDP, the Economist claims that minimum wage should be $12 to be similar to other successful global economies. This number is also eerily similar to the minimum wage way back in 1968, adjusted slightly for increases in worker productivity.

Put simply, who knows what should happen. The employment and ethics numbers might point towards not changing (or event abolishing) the minimum wage, whereas comparisons with other thriving nations could say the exact opposite. It’s a complicated economic problem, and it could be a deciding factor in the polls this year.

Subprime Mortgage Crisis

Money rules the world we live in. Be it salaries, taxes, or prices, citizens all around the world are constantly focused on the green. It has become such a driving factor in the society we live.

Money, however, can have a dark side. It can make people do things. It can be unethical, corrupt, slimy, and shady. In the course of this blog, I’d like to explore the ethics of money. There a plethora of topics which can be analyzed through this lens, and I will do my best to select germane and interesting ones.

*          *          *

While I muddled through the end of elementary school around 2007, the world seemed fine to me. I didn’t have any major complaints (yet) about the world I lived in. Needless to say, my ignorance to the financial crisis that shook the American and international economy starting in 2007 truly was bliss.

In 2007, the subprime lending bubble collapsed. Leading up to this time, many borrowers were now suddenly able to get loans to finance primarily home payments for mortgages far beyond their means.

Courtesy of Investopedia

Representatives of the major banks and loaning institutions were getting filthy rich from the homes their clients were buying, so the developed a lax – incredibly too lax – policy of checking client’s chances to default on the mortgage. Known as NINJA loans, a play on the abbreviation NINA for no income no assets, these loans were risky to begin with. As the market continued to grow, these shaky investments became the bedrock on which certain economic facets laid.

First, let’s start with causes and potential culprits of the crash. Lenders are most often cited as the chief perpetrator. It is these mortgage writers that actually lent the money in the subprime loans – dubbed subprime in reference to the poor credit of the borrowers. Following the dotcom bust in the early 2000’s, banks were striving to stimulate growth by lowering rates, further pushing investors to increase their risk tolerance and lenders to seek out riskier loans.

However, the blame cannot be totally levied on the corporate finance side of the issue. Homebuyers themselves, too, are very responsible for the financial meltdown. These buyers were utilizing nontraditional mortgage techniques to purchase homes that far exceeded their incomes. When the bubble began to pop due to a variety of economic factors, buyers’ equity disappeared as home prices fell.

There is a third significant player in all of this mess. Investment banks began implementing a unique new financial instrument: Mortgage Backed Securities, or MBS’s. These investments allowed further trading of the debt held in mortgages, thereby freeing up more capital and liquidity, thereby refueling the bubble to grow even larger as the market loosened up. These MBS’s were also known frequently as Collateralized Debt Obligations, or CDO’s, named for the debt that the investors were trading.

Courtesy of Investopedia

CDO’s are a complicated beast, as I learned from the phenomenal film The Big Short, which I encourage all of you to see. Simply put, CDO’s are a type of MBS in which there a series of tranches. Each tranche corresponds to a different rating of the underlying mortgages or other derivatives. The upper tranches are safe, stable, AAA ranked instruments. Lower tranches contain the junk investments. As 2007 neared, CDO’s were becoming much more skewed towards the bottom tranches, even though the presence of only a few AAA securities in the upper tranches kept the rating pristine.

Rating agencies can be to blame for some of this conflict. Whether they were simply inept or acting for corporate gain in the form of fees from banks is unclear. However, it is reasonable to assume that proper ratings would have discouraged some investors from taking on the risk that they did by buying CDO’s, possibly easing the crash.

If it’s not clear yet, the economy of the time was a turbulent one that resulted in a crippling burst domestically and internationally.

As a result of the crash, Lehman Brothers basically went extinct. Two other enterprises, Fannie Mae and Freddie Mac, were seized by the federal government. In response to the burst, it became vastly more difficult to get housing loans, further deepening the recession that followed and prolonging the path to recovery.

The Federal Reserve stepped in and backed themselves up against the zero bound, forcing interest rates as low as possible (the eponymous 0) in an attempt stimulate economic activity. The foreclosure dilemma has persisted along with soaring unemployment and difficulty getting loans.

The boom and bust of the subprime loan industry was catastrophic for the global economy. However, it was indeed telling. Many sources have looked in to preventing such catastrophes in the future, such as the FDIC. Hopefully, such a crash can be prevented next time through clear foresight.