The Impractical Economics of Bernie Sanders

Extremist views don’t mesh well with economics.  While they often sound good in theory they don’t work well in practice.  This was the crux of much of my criticism of the Republican debates last week (see my comments on the gold standard and Rand Paul’s views).  Unfortunately, some of the same (well, very different actually) extremist views are on display in the Democratic debates.  Bernie Sanders is front and center here and while his views often sound good in theory I think they can aptly be described as populist, extremist and largely impractical.  Let’s explore a few of his core views on economics:

Sanders wants to raise the federal minimum wage to $15, a %100+ increase from the current rate of $7.25.  This sounds good in theory, but there is ample research showing that this could be a very dangerous price increase.  Yes, when it’s wrapped in the usual Sanders rhetoric about how corporations are evil, greed loving entities that need to redistribute more of their wealth to the middle class, a bigger wage increase sounds that much better.  But we have to be smart about this.

The states in the USA are not the same.  There are microeconomies inside of the US macroeconomy.  After all, a wage hike in New York is not the same as a wage hike in South Dakota because the cost of living is totally different.  When the federal government enacts a broad price hike they are imposing a cost on businesses that will impact many companies in much more harmful ways than others.  Luckily, we have some pretty good research on the topic and even leading Democratic researchers on the minimum wage are worried that $15 would be too much too fast (see here and here).

Now, in fairness, Sanders isn’t all that clear on the timing of his wage hikes.  He’s proposed legislation that would phase in the hikes over the next 5 years, but who knows what he’d do once he got into office.  After all, this is a man who has stated that he’ll definitely raise taxes on the rich, but isn’t sure what that rate will be.  What he did reassure us of was that it wouldn’t be 90% like it was under Eisenhower.  How reassuring…

Tearing down the big banks is not only impractical, but pointless.  Bernie Sanders has an incredible amount of hatred for this thing he refers to as “Wall Street”.  At the center of this hatred is his idea that Glass Steagall needs to be reinstated so big banks can’t hurt the economy. This is based on a total misunderstanding of the cause of the financial crisis and the financial system.

First, Glass Steagall would not have protected us during the financial crisis. Remember, the sales pitch for bringing GS back is about separating plain vanilla banking from investment banking and other riskier forms of finance.  But the financial crisis didn’t occur primarily in the “supermarket” firms where investment banking and banking were commingled.  It occurred largely in the most plain vanilla market of them all – the mortgage market.  And while there were certainly some supermarket style firms (like Citi) who were dangerous there were plenty of plain vanilla banks (like Washington Mutual) who failed along with totally separate investment banks (like Lehman).  We had separate investment banking and plain vanilla entities who managed to blow themselves up without the help of the supermarket financial model.  Glass Steagall would not have stopped the housing boom or the bust from occurring.

More importantly, breaking all of these large entities into smaller entities does not mean they won’t be interconnected.  After all, the reason they’ve merged over the years is because they’re so interconnected in the first place.  The investment banks are customers of the banks who are customers of the brokerage houses who are customers of the stock exchanges, etc, etc.  The financial system is highly interconnected.  You can break up who technically owns which parts, but you can’t make it all less interconnected.  So, we can separate the ownership, but that doesn’t mean the next 2008 won’t happen because you separated the next Lehman from Washington Mutual.

Bernie Sanders said “the business model of Wall Street is fraud”.  This is the sort of comment that convinces me that Bernie Sanders doesn’t understand the financial system all that well.  After all, this is no different than saying that all Muslims are evil because Jihadists attacked Paris over the weekend. That’s just silly and it’s based on a dangerous and ignorant generalization. What is he saying exactly?  Is he calling every accountant, banker, financial analyst, financial planner, manager and sales person on “Wall Street” part of a fraudulent cartel?  This is nothing more than populist rhetoric that some people get charged up about only because they don’t understand the thing they hate.  Yes, there is some fraud on Wall Street, but that does not mean the business model of Wall Street is fraud. We’re talking about almost 6% of the entire US workforce.  Does Sanders really think 6% of the US workforce is engaged in fraud?

The next President of the United States shouldn’t engage in earning votes on such lazy and populist thinking.  But what’s more alarming, in my opinion, is that Bernie Sanders says these kinds of things because he simply doesn’t seem to understand the financial system or economics all that well.  And that makes an extremist that much more dangerous.  In a lot of ways he’s perfectly juxtaposed in these discussions as the Democratic version of Rand Paul.  And while the commentary often sounds good in theory it’s often based on a total lack of understanding about very important topics.