The New President's Economy Problem

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REAL ESTATE
$80 billion
A HOUSE IS THE AMERICAN DREAM — BUT THE TAX BREAK IS COSTLY

Some 1.5 million U.S. homes fell into foreclosure in 2007, and the number will probably be even higher this year. Congress is debating a bill aimed at slowing this tsunami, but the window to act is rapidly closing. Next year the focus is likely to turn to preventing a rerun of the real estate debacle. An exact repeat is already unlikely; bleeding banks have toughened lending standards, and the Federal Reserve is tightening its mortgage rules, squeezing out most of those "no doc" mortgage mills.

The mess has also caused some economists to question why we subsidize housing so heavily in the first place. The tax deduction for home-mortgage interest alone costs the government about $80 billion a year, and most of that benefit flows to the wealthiest 16% of taxpayers, according to the Tax Foundation. It also means we're subsidizing bigger houses and home-equity loans, possibly at the expense of other investments that might deliver a bigger economic bang. Money spent on a factory, a piece of equipment or a software program can pay off in higher growth and productivity. A house just sits there.

Several countries have dropped the mortgage-interest deduction in recent years, with no noticeably adverse effects, but there's no indication that any of our presidential candidates are contemplating such a move. What is likely to be on the next Administration's agenda are measures to restrain Wall Street — which, by buying and repackaging hundreds of billions of dollars in dodgy home loans, played a key role in bringing on the housing bubble and bust.

Current Treasury Secretary Hank Paulson has already proposed a sweeping revamp of the financial regulatory structure. What hasn't really been answered yet — but could be by a new Administration — is whether we need an entirely new regulatory approach. Ever since Reagan took office, the approach has been to get out of the way and let financial markets work their magic. Now that it's clear just how much of this is black magic, there's a case to be made that financial innovation — especially when it's targeted at consumers — could do with much stricter oversight.

FINANCIAL SECURITY
47 million uninsured
HEALTH CARE AND RETIREMENT SCARE YOU? YOU'RE NOT ALONE

Ronald Reagan uttered another line in that 1980 debate with Jimmy Carter that has entered the history books: "There you go again," he chastised his opponent. What's less well remembered is what that was in response to. Carter had been making the case for national health insurance and said Reagan had once opposed Medicare. Reagan objected that Carter was misrepresenting his position — he had simply opposed a particular Medicare bill. But Carter was absolutely right that Reagan wasn't for universal health care — or for any other government effort to socialize risk.

In the seminal PBS series Free to Choose, which aired in 1980 and may have helped set the mood for Reagan's victory, economist Milton Friedman argued that economic freedom was just as important as all those freedoms written into the Bill of Rights. This went on to become perhaps the most consistent theme of the Reagan economic era: giving Americans the freedom to succeed or fail on their own economically was a good thing. And it is probably a good thing. But not an unmitigated good. Economic security matters to Americans too. And finding ways to offer more of it may be the basis of the next big economic-policy revolution.

Economic changes over the past three decades — many the result of government decisions — have "left working families up and down much of the income spectrum living with fewer economic protections, bearing more economic risk, chancing steeper financial falls," writes Los Angeles Times reporter Peter Gosselin in his new book High Wire: The Precarious Financial Lives of American Families. This Great Risk Shift from governments and corporations to individuals, as Yale political scientist Jacob Hacker labeled it in the title of another book on the subject, has become one of the defining economic realities of our age. Some aspects of it are still in dispute: economists can't seem to agree on whether jobs really have become less secure than they were. But others are undeniable. "No one argues that Americans aren't shouldering more of the risk on health care and retirement than they used to be," says Hacker.

That you're-on-your-own ethos is already beginning to change — a little. In 2006 Congress passed a law that has brought positive changes to the 401(k) savings plans that for many Americans have replaced pensions. But the majority of private-sector workers in the country aren't offered a 401(k) or a pension, according to the Employee Benefit Research Institute. All three candidates have talked of creating a new system of portable retirement accounts for those who don't get one through employers, with Obama's plan the most ambitious.

Then there's health care, which has become perhaps the biggest source of financial worry and occasional disaster among middle-class Americans. A 2005 study found that half of all personal bankruptcies in the U.S. were attributable at least in part to medical costs.

But there's real hope on this front. It is possible to conceive of a system that brings the 47 million uninsured into the fold, improves medical outcomes and costs less than what we've got now. It's possible to conceive of because many other wealthy countries already have such systems. Figuring out exactly how to make universal health care work in the U.S. is a matter better left to its own lengthy magazine article. But if you're looking for big economic change from the next Administration, this is the form it's most likely to take.

The key, really, is to accept what works about the existing U.S. economy and attack what doesn't. Reagan never dismantled the core elements of the New Deal, and the new President needs to take care not to thwart the dynamism unleashed by Reagan. But putting off change won't be an option much longer.