Unintended Consequences

You may have heard of the ‘Butterfly Effect’…a butterfly flaps his wings here in America and sets off a tornado in Japan…or so the saying goes. It’s a metaphor used to explain how small changes can create large unintended results.

The greed and mismanagement that dominated the executive offices of America’s largest banks over the past decade caused what is now called The Great Recession. The banking industry was brought to the verge of collapse; unemployment rose well above 10%; consumers and businesses severely curtailed spending and our economy came to a screeching halt. Our government leaders hopped on white horses intent on ‘saving the day’ with an array of new legislation, regulation and corporate quasi-takeovers. Enter, the Butterfly Effect. Let’s look at a couple of the unintended consequences of government intervention.

Extension of unemployment benefits. With so many people out of work and unable to find jobs, it makes sense to extend the period of time people can receive unemployment benefits, right? A business owner tells this story. “On a weekly basis, I have people coming in asking if we are hiring. If I say ‘no’, then they ask me to sign a form indicating that they sought employment which is one of the requirements to remaining on unemployment benefits. If I says ‘yes’, the person asks if he can be paid in ‘cash’. If I say he’ll receive a payroll check, he moves on to the next business. Why? Because he wants to keep his unemployment check coming in and hopes to earn some ‘non-reported’ income.” Many others who are receiving benefits have found that they can manage on the unemployment checks so, ‘Why work if you don’t have to?’ So by extending unemployment benefits, the ripple effect is that unemployment itself is also extended. Now it is true that there are lots of people who are trying very hard to find a job, but as long as you extend benefits, you can bet re-employment will be a slow process.
Lowering of interest rates. When the financial crisis began to unfold, our government reacted by lowering interest rates to zero (Federal Funds Rate). The idea was to slash interest rates in order to encourage borrowing and spending by businesses and consumers. In addition, the government jumped in bed with our largest bankers and loaned them an unprecedented $700 billon dollars to keep them afloat and allow them plenty of cash to lend…which is their primary function. So how did it work out? Well, the bankers hoarded their new-found cash and eighteen months later, they’re still not lending. They can borrow at 0% and earn a spread investing in treasuries or commercial paper without taking any risk. A VP of the Southeastern Business Division of one of the nations largest banks said that from January through August of 2009, they made no loans and that for 2010, they had made only 18 loans. Worse, current retirees who depend on interest income to pay their bills have seen their cash flow slashed and as a result…are not spending money!

So how do you jump-start an economy where the banks aren’t lending money to businesses so that they can expand and hire new workers; retirees can’t afford to spend money; and many unemployed workers are gaming the system? One answer is for the government to spend more money. But at what Butterfly Effect?