Issues: The Economy: More Trouble Ahead (CQPolitics.com)

It's going to take a long time to dig out from the damage of the economic storms now buffeting the country. Every aspect of the next president's agenda will be affected by the banking crisis, the credit squeeze, the housing market meltdown -- and the fallout for ordinary Americans who are losing their jobs and homes.

The task at hand is both short-term and long-term. The next president will be confronted with the immediate questions of how to restore economic growth and promote employment, and the more fundamental problem of how to re-create the nation's financial regulatory system and prepare current and future workers for jobs in a changing world.

In effect, the president will have to continue the work to fix Wall Street while making sure the emergency in the world of finance doesn't translate into a crisis in the broader economy. While this will involve tax and spending policies, a large part of the job will be psychological, shoring up public confidence that it's still safe to invest.

"The magnitude of the financial upheaval is the largest since the Great Depression, but so far the effects on the real economy have been much more modest," said Morris Goldstein, senior fellow at the Peterson Institute for International Economics. "In the end, it's the effects on Main Street that are going to matter most to most people. You're at a stage where you're trying to cut off the financial turbulence and insulate it from having really big effects on the real economy and the growth rate."

Righting the Ship Experts often say that the president and Congress can do little in the short term to fix the economy. Lawmakers' tools are largely limited to fiscal policy, and that instrument typically isn't either fast or sweeping enough to make much difference. But that doesn't mean the next president won't try, especially in an environment where Americans increasingly will be looking to their government for help. Growth is expected to slow to almost nothing by the end of this year, consumer spending may actually contract for the first time in almost two decades, companies have eliminated positions all year long and the unemployment rate now exceeds 6 percent, and the souring global economy is expected to pinch U.S. exports, which have been one of the few bright spots.

The central question, of course, is whether the billions of dollars the federal government is planning to spend to bail out banks and other financial firms will have the hoped-for effect of preventing the damage from being even worse. The next president will need to steer the continued cleanup on Wall Street, find a way to ensure that banks can amass the capital they need to lend, and consider policies that will help the housing market stabilize.

Beyond that, the next president will have to weigh the demands for federal aid from different industries and constituencies, who already have begun to clamor for relief from economic pressures.

Congress last month cleared legislation that will give floundering Detroit automakers a $25 billion loan. Homebuilders, meanwhile, are asking for a $15,000 tax credit for homebuyers to stimulate housing demand. And after the Senate killed a $50 billion stimulus package that would have included money for infrastructure and various forms of government aid to the poor and laid-off workers, unions and other groups supporting the measure redoubled their lobbying efforts.

Democrat Barack Obama is of the school that targeted stimulus spending would jump-start the economy. If Congress doesn't get to it before the end of the year, he pledges to seek a $50 billion package if he's elected. Republican John McCain has said he prefers using tax incentives to stimulate business growth rather than a government spending approach.

At the same time, economists on both ends of the political spectrum say it will be important for the next president to set priorities and to rein in spending, particularly in an atmosphere where so much federal money is already being spent to address problems on Wall Street.

Alison Acosta Fraser, director of economic policy studies at the conservative Heritage Foundation, said it will be more important than ever for the next administration to resist pressure for handouts from businesses that are no longer viable in the current economy. "Congress and the next administration need not prop up failing firms in failing industries," Fraser said.

Diane Lim Rogers, a former Democratic staffer who currently works as chief economist at the Concord Coalition, a group that crusades against deficit spending, notes that the agendas of both McCain and Obama will now face some necessary shrinkage. The aid package for Wall Street will crowd out other spending at a time when safety net programs such as food stamps and welfare will face rising demand.

Rewriting the Rules As the economy continues to falter, experts agree the next president will need to preside over a rebuilding of the nation's financial regulatory system to avert another disaster. Even those who have long been opposed to tight, hands-on oversight, including high-ranking Bush administration officials, have changed their minds in the wake of the current crisis.

"Intermediate and longer term, clearly we're going to need major regulatory changes," Treasury Secretary Henry M. Paulson Jr. said last month at a White House news conference as banks were falling like dominoes, and the government was brokering rescues with and without the use of taxpayer money.

Meanwhile, Securities and Exchange Commission ChairmanChristopher Cox acknowledged last month that a program allowing the nation's five independent investment banks to police themselves didn't work. Today, all five have either failed, been sold or converted themselves into more closely regulated commercial banks because they were unable to raise enough capital to stand on their own when the mortgage-backed assets they held became worthless.

"The last six months have made it abundantly clear that voluntary regulation does not work," Cox said.

Both Obama and McCain also have called for a regulatory overhaul. Obama says he wants more oversight of institutions that take bailouts from the Federal Reserve, streamlining of the agencies that monitor different kinds of financial firms and new requirements that institutions must carry liquid assets on their books and do more to disclose their holdings to shareholders. McCain has called for replacing "the outdated and ineffective patchwork quilt of regulatory oversight in Washington" and bringing "transparency and accountability to Wall Street."

There are many proposals floating around for how to do this, and Goldstein has his own long list. Among his suggestions: new liquidity requirements for banks, closer oversight of credit rating agencies, better coordination between monetary and regulatory authorities, and a way for institutions that aren't banks -- such as mega-insurer American International Group Inc., which got an $85 billion loan from the Fed last month -- to work out their problems without seeking bankruptcy or asking for government aid. He also says the next president and Congress will need to return to private hands the two troubled mortgage giants, Fannie Mae and Freddie Mac, which were taken over by the Treasury last month.

Such an overhaul, Goldstein said, would be "an opportunity to make the system safer."

He concedes that tighter rules will mean smaller profits for the financial companies, but said there will be plenty of public support for the next administration to clamp down.

"There's been enough damage done that there's going to be a strong push for regulatory reform," he said. "People are fed up."

Investing in the Future Financial oversight is only one of the areas where the next president will have an opportunity to fundamentally re-shape economic policy for the long term. Both McCain and Obama say they have plans to use tax policy to stimulate economic growth -- McCain by continuing the tax cuts for higher-income Americans that were instituted during President Bush's first term, and Obama by cutting taxes for the middle class and increasing levies on the wealthy.

The Bush-era tax cuts are set to expire in 2010. Meanwhile, other pressing tax issues have been put off year after year, such as the enactment of a permanent fix to halt the spread of the alternative minimum tax to the middle class. With those pressures building, a sweeping overhaul of the tax code is possible -- even if it isn't yet likely -- and the next occupant of the White House will have an opportunity to push for changes.

Finally, economists say, the next administration will put its stamp on the vexing problems surrounding trade and employment that have accompanied the rapid pace of globalization. At stake is nothing less than the nation's role in the world economy. Free-trade agreements, and the U.S. trade deficit, averaging $60 billion a month, will be a part of this discussion, as will the dollar's relationship to global currencies. "You can't fix the economy unless you fix the trade deficit and currency imbalance," said Peter Morici, an economist at the University of Maryland.

As certain kinds of unskilled jobs have relocated to countries where labor costs are lower, the United States must find new industries to employ its workers and train its citizens to have useful and flexible skills. Spending on job creation and preparedness is an important long-term investment, said Harry Holzer, a Georgetown University economist. "My concern is that in the crisis, people will say we can't afford the kind of investments we're talking about," Holzer said. "The crisis is a short-term phenomenon. It doesn't change the long-term challenges we have."

Still, he said, workforce development and job creation may not be the first thing on the next president's economic priority list. "I think there's a lot on the plate," he said. "There was even before the bailout and the downturn. Now, the bailout and the downturn, I think, will dominate the first year of any new president's administration."