It’s (Really) the Economy, Stupid

The worst Wall Street turmoil in a generation is going to wipe every other issue off the table for the next president.

Courtesy Jesse Eisinger

Lose billions of dollars as a result of bad loans? Get a bigger bonus. Negotiate a dumb mortgage for that house you can’t afford? Get bailed out by the Fed. These are heady days in the No-Consequences Economy.

The presidential campaign has gone on for so long that it feels like one of those bad dreams in which you run in slow motion but never get anywhere. When you wake up, though, the dream dissipates into a haze almost immediately. And that’s just what will happen with the campaign: Forget everything you’ve heard and everything you’ve tried to ignore. It has all been made irrelevant.

From the moment the next president takes office, one issue will overwhelm all others: the American financial crisis. The Federal Reserve has been taking extraordinary measures for more than half a year to contain the spreading misery, including recently brokering the bailout of Bear Stearns. But the damage continues to spread.

Is it that bad? Well, yes. The threat now is to the foundation of our economic structure. Faith in the financial system is crumbling. Because of the scope of the problem, dealing with its aftermath will dominate the next president’s entire agenda.

Other concerns will still draw attention. But they will come in second. Health-care reform? Not going to happen anytime soon. Immigration overhaul? Pay no attention. Global warming? Iraq? By necessity, these issues will recede from view (though they will obviously remain problems).

The next president will take office during what may well come to be known as the Great Recession, the worst financial crisis of the post-World War II era, worse than the savings-and-loan mess and worse than the stagflation of the 1970s. It’s not just a Wall Street problem, nor does it encompass only housing (which would be bad enough). This is a lending bubble, abetted by people who borrowed against their homes, racked up credit-card debt, and loaded up with possessions. And it extends far beyond that, to indebted commercial-real-estate companies, Wall Street firms, and banks. It’s increasingly looking like the economic revival of the past few years—once celebrated on the right as the “Bush boom”—was a mirage, conjured up by excessive borrowing and irresponsible lending.

There will be blood. In March, the markets got a reprieve, as hope rose that the crisis had passed. Unlikely. Over the next year, we will continue to see home-price depreciation. And much worse. We will have more failures similar to that of Bear Stearns. Since the banking system is pulling back, it will be much less willing to lend to consumers and, more significantly, to companies, which won’t have the money to invest in new plants and research and development. That means layoffs are just beginning. Personal bankruptcy is rising, and corporate bankruptcies are starting to go up. State and local governments will enter financial crises. The future holds massive pension shortfalls and retirement agonies. The problem is that the Fed has fired most of the bullets from its six-shooter, yet the enemy advances. The next president may well be dealing with markets in a continued free fall and a Fed that’s out of ammo and suffering serious damage to its reputation.

The landscape has been utterly transformed, yet the political establishment has barely grasped the enormity of the crisis. Washington isn’t solely to blame—all the supposed financial wizards on Wall Street missed it too. Treasury Secretary Hank Paulson has announced a regulatory overhaul, but it hardly addresses any of the sources of the problem. President Bush has given a handful of typically tone-deaf speeches about the economy. But the proposals from this administration have been characteristically slow, myopic, and nowhere near ambitious enough to address the problem.

Certainly, voters have told pollsters that the economy is their No. 1 concern. But the candidates have addressed the crisis in piecemeal fashion. Only Barack Obama has shown hints of seeing the full panorama. They have advocated middle-class tax cuts, and the Democrats have talked about rolling back the Bush tax cuts. Obama and Hillary Clinton have made much of the loss of manufacturing jobs. All have beaten their chests over the high price of gas. Trade and immigration have figured in the campaigns. And of course, health-care reform has been a major issue for the Democrats. But health care is an economic challenge that has beset the country for years, and immigration and trade are not close to the heart of what has caused the current economic woes. Increasingly, such issues will be shoved to the sidelines.

Clinton raised an early alarm on the housing issue, and Obama followed. Their housing-market proposals, both calling for multibillion-dollar programs, sound big but are inadequate to address the size and scope of the disaster. And neither candidate has anything substantial to say about reforming the financial system. Obama and Clinton made statements the week of the Bear Stearns collapse, which was a start, but neither made mention of reshaping the system. John McCain is particularly out of his depth. Do I expect Obama, Clinton, and McCain to drop everything and talk only about structured finance, rating agencies, and banks’ capital requirements? Well, no.

But a federal bailout of big financial entities is a certainty—indeed, the Federal Reserve has already guaranteed billions of complex Bear Stearns loans. To the extent that those loans go bad, taxpayers are on the hook. There are billions more to come. Bush will not have the political will or firepower to set a bailout in motion, meaning the task will fall to the next president. What shape will the bailout and banking overhaul take? How will the government help underwater homeowners? Can we fix a broken Wall Street? The candidates need to start addressing this.

A great recession—and a New New Deal? There just might be reason for a sliver of cheer, however. Crises create opportunities for political realignment. After years of chasing the New New Thing, we now need, in the phrase of the moment, a New New Deal. We have had our decades of celebrating financial deregulation and a Federal Reserve chairman, Alan Greenspan, who genuflected at the altar of the free market. But now Big Government has rushed to bail out banks and investment institutions. Free-market ideology is in the process of imploding. Liberals have longed for an opening to roll back what political scientist Jacob Hacker has called the “great risk shift.”

As we have heard ad nauseam, the next president must be ready on day one. But we’ve been talking about the wrong kind of preparation. The candidates must prove they are ready for the economic crisis. Terrorism and threats from outside are not the gravest problems facing America. It’s the collapse from within.

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