The new president will face a three-part economic crisis of a magnitude not seen since the Great Depression. Remedy, in turn, will require drastic revision of the ideological assumptions that have dominated American political discourse, in both major parties, for a generation.
The president will face a financial collapse that is still deepening; an implosion in consumer demand; and international constraints on his freedom to engineer a recovery -- rising food and energy inflation and a severely weakened dollar. Preventing a slide from recession into depression will entail a more activist use of government than since the Kennedy and Johnson era. This means reviving not just financial regulation but also government spending.
On Jan. 20, the Bush recession will become the Obama or McCain recession. To succeed, the next president will have to transform public understanding of what needs to be done. If he doesn't appreciate that, he should not want the job.
On the financial front, credit markets remain in a state of severe trauma. Entire categories of securities are not trading or can be traded only because the Federal Reserve keeps pumping hundreds of billions of dollars into the banking system, an unsustainable policy.
In late July, under pressure from the Federal Reserve and the Securities and Exchange Commission, the Financial Accounting Standards Board hastily withdrew a rule that requires banks to book their assets at their current market value. Had the rule been enforced, America's major banks would be insolvent, since many of their securities cannot be unloaded at any price. Before this crisis is over, America's banks will need to be recapitalized by something like a trillion dollars -- either by foreign sovereign wealth funds and other overseas investors or by U.S. taxpayers.
The crashing sound in financial markets is also the crash of an ideology. What has collapsed is the idea that money markets could accurately price exotic assets and operate efficiently without government either setting rules or providing help.
We have been spared a depression only thanks to the portions of the New Deal that conservatives did not manage to repeal. In late July, several runs on banks occurred -- not because depositors were fearful but because shareholders, belatedly cognizant of the carnage on bank balance sheets, were in panicky flight from bank stocks. Our president, one of history's great government-bashers, said in reassurance, ''My hope is that people take a deep breath and realize that their deposits are protected by the government.'' Imagine that.
But the Bush administration and many commentators still suffer from a case of cognitive dissonance. The ideology has failed, but the melody lingers on.
For a year now, the Bush administration has been pursuing emergency regulatory interventions in practice that it does not accept in theory. Since mid-2007, the ad-hoc rescue operations conducted by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have included:
- An emergency takeover of Bear Stearns by JP Morgan Chase, at fire-sale prices, putting $30 billion of taxpayer money at risk.
- Offering a general line of credit to large investment banks that have no special government guarantee or supervision.
- Putting effectively unlimited government capital at the disposal of Fannie Mae.
- Inviting banks and other creditors to come to the Fed and exchange junk securities for government-guaranteed Treasury bills.
Most of this was done under the Federal Reserve's emergency authority enacted during the Roosevelt administration. Except for the Fannie Mae bailout, none of it had congressional authorization, nor did the Bush administration announce an explicit reversal of the general policy of financial deregulation.
It's fortunate that Paulson reversed course and pursued these massive interventions. Otherwise, this already would be a depression. But in the next administration, these ad-hoc rescues need to become a coherent philosophy of financial regulation. And they should be accompanied by explicit measures to restore tighter supervision of all financial institutions, to reduce risks to the taxpayers and to prevent another cycle of bubble-and-bail.
This will require the next president, in his role as teacher-in-chief, to educate the public about the massive failure of an entire ideology. That reversal is also necessary to remedy the prime casualty of financial deregulation -- the deepening collapse of consumer purchasing power. The cure is not just better banking regulation. Government will need to spend more public dollars than most politicians currently find imaginable.