What happens when you extend unemployment benefits?

You get situations where people turn down jobs to stay on the dole. Food stamp use is at a record high while unemployment benefits continue to get extended. A days back, I met with a local businessman and we discussed some of the aspects of his business. He has a large number of employees and says his biggest challenge is getting and keeping employees. Due to the type of business he is in, wages are always low - just slightly over minimum wage. That is what the market demands, as it is a labor-intensive business and the customers simply will not pay more. In the past few months, he stated that he is having particular difficulty hiring people because they are waiting until their unemployment runs out to go back to work. They don't want to work at $8 per hour when their unemployment plus their food stamps is almost that much. And who could blame them? If unemployment plus food stamps equals $7 or $8 per hour, why go back to work for just marginally more? In Tennessee, you can draw up to $275 per week in unemployment. That is equivalent to $6.88 per hour, based on a 40 hour week.

This is not just idle speculation. He told me that several of the potential employees have told him that they do not want to start work until the unemployment runs out. One of them told him they would be ready to start in three months, once the checks stop.

When you pay more for something, you get more of it. That is what is happening with unemployment. Look at the long-term unemployment in this chart. If you scroll down on this chart, you can see how this has compared to prior recessions back to 1990.

UPDATE: The Wall Street Journal comes forward with additional examples of this phenomenon.

Muni-Fund Yields May Point to Big Problems

It is a basic principle of finance that yields rise when risk is increased. In the last few days, look at the rise in the yield on the Vanguard Tax-Free Money Market Fund.

09/10/2008 1.65%
09/11/2008 1.68%
09/12/2008 1.71%
09/15/2008 1.80%
09/16/2008 1.83%
09/17/2008 2.00%
09/18/2008 2.39%
09/19/2008 2.80%
09/22/2008 4.05%
09/23/2008 4.46%
09/24/2008 4.83%

In one week, the yield has more than doubled. Municipalities are apparently stuggling to keep their paper financed and are having to accept higher yields to do so. For someone in the 28% bracket, this is a 6.71% return. It is a 7.21% return for someone in the 33% bracket. Folks, this is a very high return for cash when bank yields are so low. This return does not come without risk. This is strong evidence of the strain on our credit markets and the ripple effect that this crisis is having on our economy. In a matter of days, municipalities are paying more than twice as much on their short term paper.

Disclosure: I own Vanguard Tax-Free Money Market Fund.