Just today we learned that new residential construction fell again last month, while home foreclosures continue to rise.  It could hardly be otherwise: Washington has still done little to address the pressures from falling home prices colliding with rising mortgage payments, even though they were the largest single factor in the financial meltdown. We did warn that the government’s housing plan wouldn’t work:  A small government benefit to encourage banks to offer better terms to strapped homeowners couldn’t overcome the basic rule that anymore facing foreclosure becomes a poor credit risk, and banks don’t refinance mortgages for poor credit risks.  So, as jobs have continued to disappear and incomes fall, foreclosures continue to rise.  We could still declare a brief moratorium on foreclosures while putting in place some measures that might actually work – for example, directing Fannie Mae, which we taxpayers now own, to provide better terms to strapped homeowners whose mortgages are held there.

Washington also gave financial institutions hundreds of billions of tax dollars without ever requiring them to get rid of their toxic assets and reboot credit to businesses – and so, they largely didn’t.  Now, as foreclosures continue to rise, they face more losses from the mortgage-backed securities and their derivatives they still hold.  Those losses will continue to limit the credit flows needed to keep the economy going once the stimulus fades.  And that doesn’t factor in the increasing pressures on financial institutions from growing problems with commercial real estate.

And by the way, oil prices are up to $80 per-barrel again and headed higher if the dollar continues to weaken.  You may have forgotten, but it was the run-up in oil price in 2007 that actually triggered the recent recession, with the financial crisis coming a little later and making it so much worse.  If oil prices keep on rising now, on top of weak credit flows and anemic consumer spending, and the economy heads down again, its trajectory could well be even worse this time, since it will come in the context of already weak demand and high unemployment.

This possibility brings us to Washington’s largest failure of all – okay, the second largest after its astonishing incompetence dealing with the financial bubble and bust.  Throughout the last expansion, Washington sat on its hands as jobs continued to disappear for two years after the 2001 recession ended, and then finally began to grow but at less than half the rates seen in the 1990s and 1980s.  This political failure means that we now face double-digit unemployment for a long time, even if we manage to avoid returning to recession.

At least the administration and Congress finally are noticing the jobs problem.  What we don’t know is whether they’ll do anything effective to address it.  They have real options here.  For example, for the short-term, they can provide more money to states squeezed by falling revenues and balanced-budget requirements, so the states can keep their teachers, police and other employees working.  An even better idea would be to jumpstart new job creation by exempting the first few thousand dollars of wages from payroll taxes.  And they could pay for it with a small, Tobin-type tax on financial transactions.

What really scares me and some other economists, however, is the possibility of another large shock to the financial system.  For example, while it’s not likely, we could see a sudden collapse in the markets for securities backed by commercial mortgages.  The real nightmare on Wall Street, however, is an international crisis that suddenly drives up the dollar’s value.  That would present terrible problems, since much of the near-record profits being reported by Goldman “We’re doing God’s work” Sachs and others come from nearly a trillion dollars in complicated financial plays that depend on a weak dollar.

If this somehow should come to pass, Washington’s incapacity to deal effectively with the recent crisis will create very scary scenarios.  At a minimum, even President Obama’s legendary skills of persuasion won’t be enough to convince the public to bail out Wall Street a second time. It’s may not be too late, however, for the administration and the Fed to privately jawbone Wall Street to reduce this new risk exposure – and ours. Whether they’re willing to accept smaller bonuses, which usually come with less risk, could be a good test of whether they deserve to ever be rescued again.

These are my thoughts, at least, reading a new piece from Eugene Steuerle, a tax economist at the Urban Institute with a knack for collecting data that can help us see the world in fresh ways.  From the data Steuerle presents, we can calculate that within just five or six years, the average middle-class family will have to devote nearly one-third of its income to health care costs.  That’s right: one-third.  According to the CBO, the average family will earn $54,000 a year in 2016, when a moderate-priced family policy will cost $14,700.  Employers will pay much of that insurance bill for most middle-class families; but that’s just a mask, since those employer payments come out of people’s wages, not a company’s profits.   In real effect, a middle class family’s earnings in 2016 will come to $68,700 ($54,000 + $14,700), of which $14,700 or 21.4 percent will go for health insurance.  And that won’t be their only health-related costs.  Their co-payments and other uninsured expenses, on average, will come to another $5,100.  They’ll also be paying taxes to help cover other people’s health care – 2.9 percent of their cash wages for Medicare ($1,566), plus perhaps $750 more in federal and state income taxes for Medicaid and for Medicare costs not covered by the 2.9 percent payroll tax.  Add up all of that, and it comes to $22,116, or 32.2 percent of the middle-class family’s adjusted income of $68,700.

While Steuerle is concerned – rightly so – about provisions in health care reform that will treat people with the same incomes differently, depending on the rules the legislation applies to employers, I’m more incensed about the current, raw deal for middle-class Americans.  Why should an average family expect to pay one-third of its income in 2016 on a health care system which, in that same year, should claim only 16 percent of our GDP?   The biggest part of this puzzle lies in the fact that most of the costs are roughly the same for most people, regardless of their income.  The worker earning $68,700, a manager who makes $100,000, and the company’s CEO who earns $1 million all will pay the same $14,700 for their families’ health coverage. Their out-of-pocket expenses do rise with income but not by very much; and while the manager and CEO pay more Medicare taxes than our average worker, they all pay at the same 2.9 percent rate.  There also are other factors which reduce the burden on other groups – and so tacitly increase it for those middle-class families.  For example, people on Medicare and Medicaid bear much lower insurance costs, although they also pay relatively more for their out-of-pocket expenses; and families without children pay relatively less for both insurance and out-of-pocket expenses.

Whatever the causes, the data show clearly that health care costs have become a core economic issue for middle-class Americans.  Unless we can contain them, and over time even reduce them, realistic prospects of upward mobility for most middle-class families will simply slip away.   Health care, in short, has to be an essential part of a new economic strategy.

The last political upheaval over the economic prospects of the middle class began with Proposition 13 in California and went on to fuel a conservative realignment that held sway for a quarter century.   The next one may well have begun already with these unsustainable health care costs.  President Obama, whose talent for reading the American mood equals Ronald Reagan’s, has tried to respond quickly with several reasonable ideas for cost containment.  His proposals went nowhere when healthcare providers and insurers countered by, in effect, threatening to withhold people’s care.  The next time, this issue will be recast in terms that everyone understands – people’s real incomes – and the results could be very different.

We could even face more upheaval in financial markets already growing giddy again.  In fact, Nouriel Roubini, the NYU economist who warned us in 2006 and 2007 that the end of the housing bubble could wreck the financial markets, now sees a new bubble forming from trillions in new investments by financial institutions playing the declining dollar off of other currencies.  Moreover, he also sees an inevitable bust coming, with devastating new costs.  He’s certainly correct that currency plays are very risky, since exchange rates can turn unexpectedly on a dime.   That’s actually a variant of what happened to the Long Term Credit Management fund in the late-1990s.  The big bets placed by that single fund, and the liabilities of its Wall Street investors, nearly brought down the financial system.  What’s happening now is on a much bigger scale, and the underlying system is a lot more vulnerable.

If we do dodge Roubini’s latest bullet, the bad news eventually will run its course – though it probably will take at least another year, and longer than that for employment to recover.  By that time, it will be more obvious that we don’t have a national strategy to avoid another boom-and-bust cycle and produce sustained gains for most people.   It’s hard to face, but the Treasury and Congress have to give up their comforting assumption that the handful of financial institutions which dominate our capital markets are driven to behave in ways that ultimately produce good times for everyone.  In some periods, markets do work nearly as well as that – from the latter 1950s and through the 1960s, for example, and again in the latter 1980s and through the 1990s.  At other times, distorting new conditions bound the system, and markets go a little haywire.  That’s what unfolded in the latter 1920s and through the 1930s, again in the 1970s, and now it’s happening again.  So it’s time to retire the economic strategies of the last 25 years or so, which relied on efficient markets to drive those who run its largest institutions to work their will for everyone else’s benefit.

What we need now is a new debate over the terms of a new economic strategy.  One place to begin is by limiting some of the risks taken by institutions that dominate critical markets, which the rest of us also depend on.  It’s hard to do, because it’s very difficult to even measure and monitor those risks.  It also means effectively limiting the profits available to the society’s richest companies, and how often does that happen?

A greater challenge will involve facing up to the way that the fast-evolving global economy has undermined our capacity to create jobs and deliver rising incomes for most people.   It’s not about sending jobs to China.  Rather, it’s about how hard it’s become for many companies, facing intense competition from tens of thousands of new foreign and domestic businesses created in globalization, to raise their prices when their cost go up.  So as their health care and energy costs have marched up, they’ve cut other costs – starting with jobs and wages.  And whenever this crisis and downturn truly end, the intense competitive pressures that indirectly eat into the American incomes will be as strong as ever.

The debate has to begin with the recognition that in this period at least, markets won’t cure these problems.  If we truly want to restore steady wage gains, there will be no way to avoid serious government steps to slow future cost increases in health care and energy. A new strategy also has to acknowledge our only certain competitive edge in a global economy.  In the country where the idea-based economy took hold first, our companies and workers still do better than most of their counterparts elsewhere in developing powerful new innovations, adopting them across the economy, and adapting them to their own particular circumstances.   We have to generously fund both the seeds and the infrastructure of innovation.  And we should help everyone develop the flexibility demanded to operate effectively in innovation-dense workplaces, by funding universal opportunities for people to upgrade their skills and education every year.

Starting with Goldman, it’s obvious that a sheaf of annual bonuses each equal to 10 or 20 times what an average American earns in his or her entire lifetime, coming from a firm which recently received huge, direct and indirect taxpayer-funded assistance, is certain to spark outrage.   That reaction isn’t misplaced, and there’s a sensible response to it based on the core tenets of capitalism which we will get to shortly.   There are other serious matters at stake here, too.   In particular, how does a financial services firm like Goldman Sachs earn such huge profits in difficult times?  And since the operations of Goldman and a few others like it matter so much to the economy – which is why they got their federal assistance – how do the arrangements which produce such huge bonuses affect those operations and thereby the rest of us?   The answers suggest that even as Goldman’s top executives and traders put away enough for a royal retirement, their decisions could lay the foundation for future financial turmoil that would leave the rest of us a lot poorer.

We didn’t need this latest and most conspicuous instance of greed at Goldman to know that the compensation provided to the uppermost echelons of American business is out of control.  Since 1990, the pay of American CEOs has jumped from 90 times the average workers’ pay to 250 times – compared to 15 to 30 times for British, French and Japanese CEOs.   Nobel Laureate Ostrom’s work helps us understand why:  CEOs name their own top executives and strongly influence who ends up on their boards of directors – and consequently on the committees that set the terms for all of their compensation.  How much they decide to pay themselves, therefore, is essentially limited by the intersection of their own avarice and any vestigial sense of shame they might have.   And the shame is pretty easy to dispose of, since the terms of their compensation are rarely disclosed publically.

There’s a fascinating account of some of these pay packages in a current New Yorker article chronicling the efforts of Nell Minow and Robert A.G. Monks to reassert shareholder rights over these modern robber barons. Almost everywhere, most of the pay comes in stock or stock options, so they’re only liable for the 15 percent capital gains tax.  (The Goldman executives who will claim stock bonuses worth tens of millions of dollars this year will report taxable “salaries” of less than $300,000.)  And if the stock price falls under these executives’ leadership, their options contracts are often revised at a lower strike price.   These packages may also include huge “retirement” bonuses for CEOs that leave voluntarily – like the one federal contractor Halliburton gave Dick Cheney when he left to run for Vice President – and even “retention bonuses” for executives who end up in prison.  Then there are the extravagant perks.  It took public divorce proceedings against GE’s Jack Welch for shareholders to find out that on top of the many hundreds of millions of dollars Welch received in stock and salary, his friendly board had also awarded him lifetime use of the company’s 737 and helicopters; lifetime floor seats for the Knicks and lifetime box seats for the Red Sox, Yankees and the Metropolitan Opera; exclusive lifetime use of a sprawling Manhattan apartment, including fresh flowers, dry cleaning service and even the tips for the doorman; and a catalog of lifetime golf and country club memberships.   His and most other executive contracts also now include “gross-ups,” which means that the shareholders pick up federal and state taxes owed on the executives’ various perks.

These are all examples of what economists call the “agent-principal problem,” in which the interests of agents – they’re the executives – diverge from those of the principals, who here are the owners or shareholders.  It’s pretty simple: They enrich themselves at the expense of the shareholders who they ostensibly work for – and those shareholders now include a majority of all Americans.  The simple democratic answer to all this, derived directly from the essence of capitalism, is to empower the owners by requiring that boards disclose all aspects of the compensation package of senior personnel and subject the terms of those compensation packages to mandatory shareholder votes, every year.

Last week, I proposed this step on a CNBC business show.   The other guest predictably squawked about government control – and then the moderators also tried to dismiss the idea as “impossible.”  Come again?  Shareholders vote every year on lots of measures – check out your proxy statements.   And the mere threat that shareholders might publicly reject a CEO‘s payday should moderate the greed of at least some compensation committees.   The House passed a weak version of this proposal recently – annual, “advisory” shareholder votes on compensation.  The Senate should strengthen it with stricter disclosure requirements and an annual vote that actually decides the matter. Why, precisely, shouldn’t a company’s owners determine what their executives are paid?  And does anyone think that Goldman’s shareholders, including strapped pension plans and charitable institutions, are eager to see $23 billion in potential dividends go to the firm’s top tiers?

This particular agent-principal problem also affects the rest of us, since the stock and stock options that make up most of these compensation packages are often tied to the short-term gains associated with an executive or trader’s work, without regard to the transactions’ long-term returns.  So, hundreds of traders and executives at Goldman and other places on Wall Street have closed transactions and other deals that booked large paper profits this year – and will take home huge bonuses tied to them – but bear no consequences if those deals go sour next year or the year after and cost the shareholders billions.   These arrangements directly encourage them to take on enormous long-term risks for their firms and owners, in pursuit of the short-term paper gains that generate their own bonuses.   Since risk and return are closely related, these arrangements help explain how Goldman earned enough this year to dole out that projected $23 billion in bonuses.   And by creating such strong incentives for risky investments on a large-scale, these same arrangements were a core element of the meltdown that nearly pushed the U.S. and global economies into a genuine Depression, and cost shareholders and taxpayers trillions of dollars.

To prevent a recurrence that could ruin almost everyone, these arrangements have to end.  J.P. Morgan Chase has said it will include new “claw-back” provisions that would reclaim part of the bonuses when a deal’s long-term returns are less than expected.   It’s a nice gesture, but it’s hardly enough.  We need laws and regulations that directly limit the risk levels of the portfolios of institutions deemed “too large to fail,” and specific, claw-back guidelines from the SEC that all public companies will have to follow.  The outstanding question is whether Congress has the cajones to force the country’s richest people and institutions to change the ways that made them so wealthy in the first place.

America, with 23.5 percent of worldwide GDP – Japan is second at 8.1 percent, followed by China with 7.3 percent – is the only country with the economic heft to move other nations.   Much of our impact comes from our annual imports of $2.5 trillion, which help keep employment up in most other large economies.  If we could get our imports growing strongly again, the world’s finger-pointing would turn into high-fives.  But that depends on reviving American consumption and investment, and the outlook for that is mixed at best.

Washington’s optimists point to recent gains in a number of important indicators – but look closely, and they’re less encouraging.  Retail sales in August were up 2.7 percent over July, for example.  But that’s 5.3 percent below levels a year earlier, when things already were pretty grim.  It’s the same story with other measures.  Housing starts were up 1.5 percent in August, but down 29.6 percent from a year earlier; and industrial production was up 0.8 percent, to a level still nearly 11 percent below August 2008.  These are the numbers that led Ben Bernanke and Janet Yellen to caution that while the recession may be technically over, hard times could be with us for another year or longer.

The bottom line for most Americans is that the steep decline in the value of their investments and homes is driving them to cut back their spending and restore some savings.  Mostly, they’re paring down the record credit card debt they ran up during both the first stage of the recession and an expansion before it which didn’t produce income gains.  This spending slowdown is unlikely to change soon.   And as we have argued here for more than a year, jobs will probably continue to contract for two or three years after this recession ends, just as they did after the 1990-1991 and 2001 downturns.  It’s hardly a recipe for a recovery strong enough to lift U.S. incomes or the prospects of other economies.

Nor can we expect help from other countries boosting our exports.  Of our five largest foreign markets, U.S. imports are still falling in three of them (Canada, China, and the UK); and American imports in all five (Mexico and Japan, plus the other three) are still running 17 percent to 27 percent below their levels a year earlier.

What if the modest pick-up we’re seeing now only reflects the President’s stimulus package finally kicking in?  Republicans had some cynical fun a few months ago charging that the stimulus had failed, since everything was still headed down.  Now, it’s the Democrats’ turn, as its effects increase over the next several months.  The hard question is whether the economy will keep growing once the stimulus runs out.  The administration’s economic strategy depends on the stimulus triggering self-sustaining growth – by creating jobs, which boost spending and then, in turn, lead to more jobs, more demand, and finally more investment.   That’s also the basis of their financial strategy, hoping that expanding growth will bring down foreclosures and bankruptcies, easing the pressures on banks so they can lend more.

Their economic logic is perfectly reasonable; but it may be a long shot in the world where we now find ourselves.  And it certainly doesn’t take account of the possibility of yet another nasty shock to the economy.  The most likely candidate is an implosion of securities based on commercial real estate.  Price movements in commercial estate have been running 12 to 16 months behind those in residential housing.  So, they remained strong for more than a year after the housing bubble began to deflate – and then began to fall sharply in the last six months.  Now, more and more commercial developers can’t keep their properties sufficiently occupied to service the loans they took out to build them.  As they default, the securities and derivatives based on those loans also go bad.   It could be another very nasty hit, with most of the impact falling on the regional and local banks across the country that made the loans.  That’s why we’re already seeing a sharp rise in bank failures.

The good news is that the Fed and the Treasury have more advance notice this time, and they have a better idea of what works and what doesn’t.  The bad news is that at after what we’ve already been through, Washington couldn’t borrow the money required to manage the failures of large numbers of big commercial banks, with all of the fallout, without risking the credit of the United States.

There’s a good chance we’ll dodge that particular bullet.  But even if we do, the prospects for a strong U.S. recovery are slim, especially one strong enough to help the rest of the world.  And that will be the biggest, unspoken disappointment at this week’s G-20 meetings.

Take a look:

For more of Rob’s far-reaching work on the economy and globalization, check out:

• His critically acclamined new book, Futurecast: How Superpowers, Populations, and Globalization Will Change the Way You Live and Work.
• The New Landscape of Globalization - an analysis of the fundamental dynamics of globalization and how they affect U.S. growth, wages, and job creation.
• The Idea-Based Economy and Globalization – an examination of how and why US companies and workers lead the world in developing new intellectual property and why these leads in innovation constitute a critical U.S. advantage in globalization.
• A recent interview of Rob on the current state of the economy by NDN President Simon Rosenberg. Rob’s narrative covers the economic slowdown, the financial and housing crisis, and the failure of policy makers to make globalization work for all Americans.