It's The Economy Stupid 2.0

With a possible slowdown looming, the issue will be front and center

By Jane Sasseen

When the Federal Reserve cut rates by half a percentage point on Sept. 18, it was only the latest in a flurry of signs that the U.S. economy may be weakening. A slowdown could mean that, for the first time since 1992, the economy will emerge as a major issue in the campaign. Says Austan D. Goolsbee, the lead economic adviser to candidate Senator Barack Obama (D-Ill.) and a professor at the University of Chicago's Graduate School of Business: "As unease in the markets and the wider economy has grown, people want to know: What does it mean, and what are we going to do?"

The shifting winds seem to be most advantageous to the Democrats—particularly front-runners Senator Hillary Clinton (D-N.Y.), Obama, and former North Carolina Senator John Edwards. That's because, rightly or wrongly, voters tend to blame the Administration in office when the economy sours. "Now, on top of the other problems Republicans face, the economy is shaping up in a way that doesn't play well for them," says Kim N. Wallace, head of the Washington research unit at investment bank Lehman Brothers Inc. (LEH ) Says independent pollster John Zogby: "The situation should help any of the leading Democrats."

Each has put forth similar proposals. "Basic universal health care, middle-class tax cuts, increasing taxes on the wealthy, and better enforcement of trade agreements—that's their economic message," says Daniel Clifton, Washington analyst for investment firm Strategas Research Partners. But the packaging of those proposals is starkly different, with each trying to play up his or her strengths. "With Hillary it's leadership, Obama it's hope, and Edwards it's gut populism," says Zogby.

The housing crisis is a case in point. As the news worsened in August, Clinton proposed a $1 billion fund to help homeowners facing foreclosure, following a host of earlier measures. The move signaled that she stood ready to use the power of the government to solve economic crises. Political analysts say it's no coincidence that she has increasingly tried to tap into nostalgia for the Bill Clinton era—or at least its economic record. In speeches, she frequently cites the strong economy of the 1990s, arguing that if elected she would fix the economic problems created since then.

Edwards, by contrast, has ramped up the explicitly populist message at the core of his campaign, denouncing the corporate greed and outsize CEO pay he says are part of a fundamental unfairness that's cleaving America in two. It's a message that campaign advisers believe will have even more resonance if the housing crisis takes a bigger toll on the economy. "There are 10 million families over the poverty line who are struggling to pay their bills," says Leo Hindery, the longtime media executive who serves as Edwards' top economic adviser. Their problems will worsen as more adjustable-rate mortgages reset at higher monthly payments, Hindery argues—and those people form a natural part of Edwards' constituency.

Obama has also sounded the theme of a more equitable economy, but with far less confrontational rhetoric. In a Sept. 17 speech before a Wall Street crowd, he denounced the "what's good for me is good enough" attitude he says characterizes some in Washington and the business community and called for a series of measures to crack down on mortgage fraud. The next day, he proposed an $80 billion plan to trim income taxes and raise mortgage interest deductions for lower- and middle-income families, moves he'd pay for with heftier taxes on corporations and the wealthy. But he also made clear his support for open markets, arguing that restoring public trust by cleaning up abuses and creating what he sees as a more balanced tax system is in Wall Street's interest as much as the public's. The message, says adviser Goolsbee, was one of "tough love."

If the Democrats are doing a delicate dance to differentiate themselves, the Republicans face an even bigger challenge. "They are trying to figure out their footing," says Lehman's Wallace. "The Democrats will keep harping on [the economy], so [the Republicans] all know they will need to have an answer ready."

The top Republican contenders are running as fiscal conservatives who will get spending under control and keep government's role in the economy to a minimum. In the short term, that means little support for more action to help struggling mortgage borrowers beyond the proposal President George W. Bush has made to expand FHA mortgage insurance. "The key will be private-sector workouts," says Lawrence B. Lindsey, the former head of Bush's National Economic Council who is now advising former Tennessee Senator Fred Thompson's campaign. "One thing we don't want to see is for lenders to get bailed out."

But as for longer-term economic policy, most Republican contenders have said little beyond pledging to renew the Bush tax cuts. The possible problem with that tack: If the economy weakens, it'll be increasingly difficult to argue that merely extending existing tax levels will be enough to help.

Mitt Romney has been the only Republican candidate to begin to step out of the mold, albeit carefully. In early September he proposed eliminating all taxes on capital gains, dividends, and interest for those earning under $200,000. It's an idea sure to gain favor among voters who believe tax cuts are the key to economic growth—one reason analysts expect to see similar proposals from Romney's rivals on the right as the campaign heats up.

Dismissing moves by the Democratic contenders to shift the tax burden more toward high-income earners, James Bognet, deputy policy director for the Romney campaign, says: "They want to raise taxes. There are two very different visions of how to deal with an economy that many think is weakening." The key is how to position those competing visions to voters.

Sasseen is a national correspondent for BusinessWeek

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