On June 29 the Supreme Court ruled that states can enforce fair lending and consumer protection laws against national banks, overturning lower-court decisions holding that this authority belonged to federal regulators. The case, Cuomo v. Clearing House, originated in 2005 with an investigation by then-New York Attorney General Eliot Spitzer into high rates of subprime lending in black and Hispanic communities. Spitzer had found what he called “troubling” disparities in Federal Reserve data between the mortgage rates charged to minorities and those charged to white borrowers, and he sent letters to a number of national banks, including Citigroup and JPMorgan Chase, requesting information about their lending practices. The Clearing House Association, a trade group representing the issuers, sued to block Spitzer’s request, maintaining that it was subject to oversight by the federal Office of the Comptroller of the Currency and not state law. The Supreme Court decided otherwise, in what civil and economic rights advocates are calling an important victory for consumer protection.

This case hinges on a Republic-old question of federalism–the balance of state and federal power in law enforcement. Spitzer’s activism exemplifies what some have called progressive federalism–states stepping into the regulatory void left by reticent federal agencies. This kind of local muscle-flexing is not limited to the legal sphere. In recent years states have also taken the lead in providing vital social services in response to federal retrenchment on critical safety-net programs. But times have changed. In this recession, while states can still play a central law enforcement role, they are in such dire financial straits that they lack the resources to meet the surge in basic human needs and have reached the limits of what could be called safety-net federalism. In this fiscal emergency the Obama administration must take up the slack, with more leadership and more federal dollars. The $787 billion stimulus package began to shore up flagging state efforts, but much more needs to be done.

Clearing House underscores the importance of regulatory federalism in hard times. The conditions that prompted Spitzer’s initial investigation–disproportionately high rates of subprime lending to blacks and Hispanics–have only worsened into foreclosures. The New York Times reported in May that in its own metropolitan region, defaults in predominantly minority census tracts are three times those in mostly white ones; in 85 percent of the most foreclosure-afflicted communities a majority of homeowners are black or Hispanic, reversing recent and important gains in homeownership in those communities. New findings from the Pew Research Center show similar data nationwide.

Behind these statistics, and antiseptic words like “pre-emption” and “devolution,” are the real-life stories–names, faces, evictions, anxious children–of poor people caught in the economic storm. Consider Olive Thompson, a 45-year-old nursing assistant, homeowner and single mother of four who was forced into bankruptcy, depleted her 401(k) and lost her job. When the payments on her adjustable-rate mortgage jumped, she lost her home, too. “It’s horrible,” Thompson told the Times. “I don’t know where I’m going.” Like so many others, Thompson is suffering the twin ravages of anemic regulation–allowing high-interest and possibly predatory subprime mortgages–and deep recession brought on by the collapse of banks that backed these loans in the first place. Current federal efforts to improve oversight of the financial services sector were anticipated and prodded by New York’s vigilance. Going forward, the states must continue to push the federal government to share in this watchdog role.

Recent changes to national environmental policy also illustrate the success of regulatory federalism in advancing reform. In 1966 California adopted emissions standards for motor vehicles. A quarter-century later, the federal Clean Air Act amendments of 1990 enacted a dual emissions standard, allowing states to adhere to the national requirements or to follow California’s more stringent regulations. In a reversal of federal policy, President Obama announced this spring that the United States will embrace the tougher California emissions and fuel-efficiency rules as the national standard beginning in 2012. A similar evolution has occurred on climate change, where the federal government during the Bush administration was egregiously slow to act. In 2006 California adopted the Global Warming Solutions Act to reduce all greenhouse gas emissions in the state by 25 percent over fifteen years. This was the first enforceable statewide emissions target, but by now twenty-one other states have emissions targets and goals in place.

In addition, states have acted in concert to galvanize federal action. In Massachusetts v. Environmental Protection Agency, twelve states sued the EPA to regulate carbon dioxide and other greenhouse gases as pollutants when the EPA claimed it lacked the authority to do so under the Clean Air Act. In 2007 the Supreme Court sided with the states. States have also forged a number of regional alliances in the face of federal inertia to combat climate change. The Regional Greenhouse Gas Initiative, for example, comprising ten Northeastern states, is working to reduce greenhouse gas emissions via a cap-and-trade system. This kind of tradable emissions regime is at the heart of the national climate legislation, the Waxman-Markey climate bill, which narrowly passed the House in June. As with consumer protection, state activism on the environment provided an important national road map–and must continue to complement federal efforts in the years to come.

Unlike regulatory federalism, however, safety-net federalism–states taking the lead in providing and funding core social services–has been devastated by the recession. Across the country, states are broke, squeezed between precipitous drops in tax revenue and constitutional mandates (in every state but Vermont) to balance their budgets. According to the Center on Budget and Policy Priorities, forty-eight states are reporting deficits totaling nearly $166 billion, projected to reach, cumulatively, $350-$370 billion by 2011. Although many states have attempted tax increases, these are politically challenging and often insufficient to close the gaps. Consequently, statehouses have been forced to cut vital social services at a time when the need for them is ever more desperate. The American Recovery and Reinvestment Act, the federal stimulus package, includes assistance to states to help offset revenue shortfalls. Although in most states ARRA support has helped to avert more drastic cuts to healthcare, education and other public services, at its current level the stimulus will stanch only 40 percent of the hemorrhage. The federal government must reaffirm its financial and political commitment to girding the nation’s social safety net. In the short term, since the federal government can run deficits, this means sending more money to the states, either through a second stimulus bill or a more immediate cash infusion (American Prospect editor Robert Kuttner has suggested that Congress pass an emergency revenue-sharing law). Over the longer term, this means leadership on much-needed reforms.

State cuts to social services are occurring across the board, but the heaviest of them fall on programs serving the most vulnerable, where states shoulder a disproportionate–and now untenable–share of the financing burden. Take the case of early childhood education, a classic story of safety-net federalism. When funding for Head Start stagnated under the Bush administration (just the failure to keep pace with inflation amounted to a 13 percent slash in its budget), states responded by developing free pre-kindergartens. Between 2002 and 2008, state spending on pre-K doubled, from $2.4 billion to $4.6 billion, increasing enrollment by 60 percent to more than a million children. Today, because these pre-Ks remain a discretionary line item on most state budgets, they are subject to severe recessionary cuts. The Obama administration has wisely reclaimed a larger federal role in early childhood education, including a $2 billion infusion for Head Start and Early Head Start programs. This is important progress toward ensuring universal access to high-quality preschool.

In recent years, states have also made important strides on healthcare by expanding coverage for the now 46 million uninsured Americans. In 2006, for example, Massachusetts enacted legislation aimed at universal statewide coverage by requiring people to purchase health insurance and subsidizing those with limited means. Many have cited the Massachusetts example as a possible model for universal healthcare at the national level. Other states expanded their S-CHIP programs to cover low-income children and families who could not afford private insurance but whose incomes exceeded the Medicaid threshold. Yet even before the recession, states struggled to cover these costs. On average, Medicaid accounts for 21 percent of a state’s budget. In recent months the Medicaid rolls have swelled considerably, putting greater strain on states that cannot afford to keep people insured. (The Massachusetts plan, which depends in part on expanded Medicaid enrollment, is now in jeopardy. Tax revenues have lagged 35 percent, and even with increases in sales and other local taxes, the 2010 Massachusetts budget includes cuts to healthcare and mental healthcare, education, affordable housing and other human services.)

During the 2001 recession, which by almost every measure was milder than today’s, thirty-four states cut eligibility for public health programs, resulting in loss of coverage for more than 1 million people. Although the federal stimulus plan will help bolster state funds for Medicaid, this is only a short-term fix. The $33 billion reauthorization (and massive expansion) of the S-CHIP program is an important first step toward reinfusing state programs with federal dollars.

Welfare reform is perhaps the crowning example of the achievements–and limitations–of safety-net federalism. In 1996 Congress transformed Aid to Families With Dependent Children, a sixty-year-old entitlement program guaranteeing cash assistance to poor families, into Temporary Assistance for Needy Families, a time-limited benefits program intended to move welfare recipients into the workplace and toward economic independence. This act gave states the latitude to design their own welfare programs in exchange for TANF block grants: fixed sums to administer welfare reforms within federal welfare-to-work guidelines.

A number of studies show that states were initially successful in moving people from welfare rolls into the workplace. However, the TANF welfare-to-work model presumes there are jobs; in the face of today’s 9.5 percent unemployment, welfare–perhaps the critical strand of the social safety net–is unraveling. The failure of welfare “reform” to account adequately for severe economic downturns is not simply the result of rigid work requirements; it reflects a larger structural defect in fixed-sum block grants that do not adjust enough for recessionary increases in need. As in the case of Medicaid, the economic recovery legislation provides additional resources when TANF funds fall short of the spike in welfare caseloads. Yet like the Medicaid supplement, this assistance, too, will not fully cover the deficit. Roughly 20 percent of the cost increase will be borne by the states, which can respond only by increasing spending (unlikely) or slashing TANF-related funding for things like childcare or protective services.

For more than a decade, states were beacons of regulatory and safety-net activism when the federal government fell short. Though state law enforcement soldiers on, when it comes to social welfare, the center must hold. We need vast sums of federal financial and political capital to help plug the $350 billion state shortfall and to provide long-overdue leadership on the delivery of social services.