The Next Administrations 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.

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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.