It's the Economy, Stupid

I think it's fair to say that, as of this morning, economic concerns have fully and firmly eclipsed other issues in the presidential race. We're likely already in recession; the Federal Reserve is taking unprecedented steps to bail-out the financial markets; consumers are reeling from higher prices; and this may only be the tip of the iceberg. But you wouldn't know it to listen to our presidential candidates, who have remained resolutely oblivious to the nature or extent of the present crisis. For the most part, they continue to recite the poll-tested bromides that have dominated economic policy discussions on the left for much of the past decade. When they turn to the economy, the candidates compete to denounce free-trade pacts and decry excessive corporate pay. It's tough to believe that they're changing the minds of uncomitted voters that way. If the Democrats are going to prevail in November, they need to explain to voters how the Republican Party managed to derail the world's most powerful economy - and then they need to convince them that Democrats have a plan to get it back on track. But even a cursory review of the rhetoric on the trail reveals how poorly the candidates have performed at that essential task.

Let's start with Obama. A speech he delivered last month in Wisconsin lays out his approach in a fair amount of detail. It begins promisingly enough by assigning responsibility for the present disastrous state of affairs in clear and direct language:

We are not standing on the brink of recession due to forces beyond our control.
The fallout from the housing crisis that's cost jobs and wiped out savings was
not an inevitable part of the business cycle. It was a failure of leadership and
imagination in Washington - the culmination of decades of decisions that were
made or put off without regard to the realities of a global economy and the
growing inequality it's produced.

But what are those decisions? Obama simply recites the standard litany of Democratic complaints: tax cuts, trade deals, Iraq, corporate lobbying, CEO pay, and outsourcing. The mortgage crisis, he argues, was simply "the straw that broke the camel's back." You'll forgive me, senator, if I don't join you in blaming NAFTA for this recession. Obama seems to have mistaken the peripheral for the central, and the central for the peripheral.

Hillary, remarkable though it may seem, has been even further from the mark. She, too, starts by assigning blame:

[T]he problem with our economy is not the American people. Instead, the problem
is, in part, the bankrupt ideas that have governed us for the last seven years.
They have rewarded the very few at the expense of the many.

But it's tough to tell, from her speeches, precisely what's gone wrong - just that it's all Bush's fault. The speech almost immediately turns into a laundry-list of popular policy proposals, many with their own catchy names. The highlights include suspending foreclosures and adding green-collar jobs in the short-term, and then looking forward by addressing the energy crisis, investing in infrastructure and education, expanding unionization, reforming the tax code and health care, and encouraging saving for retirement. It's all part of her Economic Blueprint for the 21st Century. And they may all be worthy notions, even if the particulars are debatable. But other than suspending foreclosures, none of them is more than remotely connected to the present crisis.

So let's detail what neither candidate seems willing or able to say on the stump. The present crisis is indeed the result of decades of poor decisions made by successive administrations, compounded by the specific policies embraced by President Bush and his appointees. But it's not (mostly) about any of the problems listed by the two candidates.

We face our present crisis because the government chose to abdicate its regulatory responsibilities in favor of blind faith in the marketplace. Seventy-five years ago, after the worst financial catastrophe in our nation's history, FDR oversaw the passage of an extensive regulatory regime intended to insure that such a collapse could never happen again. Over the subsequent decades, as the financial system evolved and banks found innovative ways to evade these regulations in the pursuit of profits, those rules were updated in an effort to keep pace with the changes. Then, during the Reagan administration, there was a fundamental change of course. Instead of trying to keep up with changes, regulators began racing in the opposite direction, hurrying to remove regulatory hurdles in the interests of growth.

The theory was simple. Spreading risk over a broader array of institutions and investors would serve to diminish the exposure of individual banks, thus accomplishing by market forces what once required regulation. These institutions could then offer an array of innovative products that would benefit consumers. The theory was also spectacularly wrong.

The result was a failure on two separate (though related) levels. The first failure has become evident over the past couple of years. A frenzy of irresponsible lending and borrowing, fueled by structural innovations like the securitization of mortgages, fueled a spectacular real estate bubble which is now collapsing. That led to the second failure, which is now being revealed in spectacular fashion. Financial institutions assumed risks they neither accurately assessed nor fully understood, while outdated rules and passive regulators failed to curtail their excesses. Now the music has stopped.

Two particularly vivid incidents can serve to illustrate this two-tiered failure. In 2001 and again in 2004, Office of the Comptroller of the Currency successfully pre-empted the attempts of state regulators to reign in some of the worst excesses of the marketplace, arguing that only the federal government had the right to intervene. It will come as little shock to learn that OCC is a classic captive agency, receiving 96% of its funding from the banks it's supposed to be supervising. Its primacy affirmed, OCC sat on its hands, refusing to act until it was far too late.

The second incident is unfolding this morning. Investment banks like Bear Stearns became, in effect, lending institutions - buying up mortgages and repackaging them for sale, thus effectively setting the standards for loans in the marketplace. Banks have long been subject to extensive regulation, in part on the theory that since the Federal Government effectively guarantees their deposits, it ought to have a say in how they shoulder risk. This weekend, we learned that taxpayers will also foot the bill for the collapse of investment banks. Alas, there is no similar regulatory scheme in place to limit their risks.

So let's return to the campaign trail, to explore the remedies being proposed by Obama and Clinton in response to the present crisis. To his credit, Obama has gone further than Clinton in focusing attention on the problem of irresponsible lending and borrowing. His platform highlights two particularly useful proposals: the STOP FRAUD Act, which would crack down on some of the most abusive lending practices; and the HOME score, which would provide a simple metric (like an APR) for borrowers to measure the costs and obligations to which they are agreeing, empowering them to act more responsibly. Both candidates have proposals to limit foreclosures. Hillary wants to do "everything possible to ensure that we don't lose any more homes" to foreclosure, calling for a 90-day moratorium, a five-year adjustable-rate freeze, a $30 billion fund for local communities, and a package of similar measures. Obama proposes bankruptcy reform (which would effectively pressure lenders to be more proactive in restructuring loans) and a generous mortgage tax credit targeted at lower income households. Most economists are agreed that Hillary's bailout would trade the possibility of short-term relief for the certainty of long-term problems; the verdict on Obama's proposals is more split.

It's easy to get wrapped up in the debate over these specifics, but that debate omits what the candidates have left unsaid. Both remain firmly committed to the notion that homeownership is an unequivocal good that ought to be enjoyed by the broadest possible number of Americans. That's the sort of thinking that landed us in this mess in the first place.

So here are two heresies that both candidates need to embrace if they're going to address the present crisis and convince voters that the Democrats have faced up to our economic problems, and have the solutions we need:

Regulation is what makes free markets function:
Every speech the candidates deliver this spring must include this essential theme - We're plunging into a recession because Republicans removed the regulations that make our economy run smoothly. And, of course, its corollary: We can rebuild our economy by standing up to special interests, and passing rules to make the markets run freely and fairly. There's no need to shy away from this sort of talk. Most Americans understand instinctively that's something has gone horribly wrong, that financial institutions have behaved with breathtaking irresponsibility, and that it shouldn't be allowed to happen again. John McCain, to the extent he pays attention to the economy at all, tends to embrace the gospel of the free markets. He and his party are largely responsible for what's gone wrong; Democrats can make a compelling case that they can set it right.

Sometimes, homeownership is a nightmare, not a dream:
When ownership can only be achieved on terms that rely on rising prices or the prospect of future wealth to finance the deal, then families are better off renting. By extension, some families are now in homes that they can't afford and shouldn't have purchased. We don't just need policies that will prevent foreclosure - that amounts to denial, and will perpetuate this mismatch of resources and obligations. We need to develop mechanisms to ease the painful adjustment, enabling families to extricate themselves from ill-advised loans without either fully absolving them of responsibility for their decisions or sentencing them to financial ruin, and without precipitating a further collapse in the market. We need to admit that home prices were artificially inflated, and aren't going back to where they were anytime soon. And then we need to change the huge array of federal homeownership incentives to embrace a more reasonable goal - equal access to homeownership for all who can afford it.

There's still time to make this economic case. Each candidate can frame it in the terms with which they are most comfortable. Obama can speak of the failure of leadership in Washington, which has allowed special interests to defeat regulation, and preyed upon the aspirations of Americans. Hillary might unveil seven discrete proposals, all part of her New American Dream Plan, designed to reform the financial industry and homeownership. I'm not going to detail the specifics. Reasonable people can disagree over both the precise nature of the failures and the proper remedies. The whole point of a campaign is to hear the candidates articulate their own understandings of the crisis, and to lay out their particular solutions. So far, however, all we've heard is silence and denial. And that's not going to put anyone in the White House.

Transforming the debate requires three simple steps. The first is to pin blame where it belongs - not on NAFTA or the decline of unions or an inequitable tax code or an unaffordable war, but on a failure of regulation and on policies that fueled a housing bubble. Then the candidates need to stop pretending that everything will be fine again, and speak a truth most Americans already know and are ready to hear - we've had a binge, and we're going to have a long, painful hangover. And that will set the stage for a message that can win in November - policies and proposals to set us on a path toward renewed and responsible growth, consistent with our values and consonant with our aspirations.

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