A woman looks at job postings with her son at the Virginia Employment Commission office in Alexandria, Virginia. REUTERS/Molly Riley
 
Conventional wisdom among progressives is that social reform is best carried out at the federal level. The New Deal and the 1964 Civil Rights Act, both of which were resisted at the state and local levels, are the classic paradigms for liberal reform. As Suzanne Mettler argued in her book Dividing Citizens, the federal programs of the New Deal, like Social Security, all became known as liberal programs.

By contrast, other programs, like Aid to Families With Dependent Children, were left to the states. The results were mixed. Some states were stringent, others moderately generous. But at the local level, eligibility for benefits was determined by local authorities. At the federal level, by contrast, all who met a minimum criterion were eligible for benefits. The process of judging people, often humiliating, was minimized.

As Mettler notes, “What it meant to be an ‘American citizen’ meant very different things to the retired male breadwinner, who came to expect his monthly social security check from the national government, and to the poor mother who hoped that the social worker assigned to evaluate her eligibility for a meager welfare check would find her child-rearing and housekeeping efforts worthy.”

Would more control of welfare at the top have made sense? Possibly. The federal government is better suited to setting baselines of universal coverage, thereby avoiding a race to the bottom among states in terms of regulations, benefits and taxes.

But in recent years, serious questions have arisen about the reliability of federal regulation. Consider the 2003 Georgia Fair Lending Act, intended to minimize mortgage abuses. There had been a wave of foreclosures and abusive practices in the state, and the new law restricted excessive charges and imposed severe penalties if the rules were not followed. But then federal banking regulators at the Office of the Comptroller of the Currency (OCC) announced that they would allow the national banks to ignore this rule. Georgia now has the fourth-highest foreclosure rate in the nation.

Pre-emption of local laws by federal regulators is hardly new. But it highlights what has become a growing tension between federal and local reformers. In the case of finance, federal regulators friendly to the big banks overturned state reforms time and again. Such pre-emption was a major reason states and their attorneys general were unable to stop the subprime mortgage crisis before it happened.

It has become all too clear that some federal regulators have been “captured” by the very industries they regulate. The OCC, the Securities and Exchange Commission and others—not least the Federal Reserve itself—have all been credibly accused of letting this happen. State and local governments tend to be less vulnerable to such pressures—and their employees less likely to take a future job in the lucrative industry they serve.

Moreover, state and local governments, working closer to the ground, often have more information about abuses and how to control them. A one-size-fits-all national reform strategy doesn’t always work. Also, because states may be more responsive to local constituencies and understand local needs, they can more appropriately serve as “laboratories of democracy.”

On the other hand, state governments are also subject to capture by powerful local vested interests. And they often vie with one another to attract businesses, setting off a race to the bottom in terms of tax rates, subsidies and lighter regulation. Federal action can forestall such parochial battles.

The financial crisis and the failure of federal regulators have shown that state and federal reforms should be balanced. One

approach would be for Washington to develop regulations that serve as a floor, not a ceiling. The federal government would demand that a minimal set of requirements be met. States could supplement and amend the rules, based on their particular situations, while the federal government guarantees that a basic level of rights, regulations or reforms is maintained.

When the federal government pre-empted the Georgia law, it went far beyond setting a minimal standard. State officials could see what was happening in local lending markets. Homeowners were being deceived. As law professors Kathleen Engel and Patricia McCoy point out in their book The Subprime Virus, the OCC simply overruled the state. There is little recourse for states once the federal government pre-empts their laws. Such action even prohibits borrowers from suing national lenders for abuses under state law. All that can be done is to complain to other federal regulators, a wholly undemocratic process. The nature and strength of the local democracy is suggested by the kinds of groups that joined to stop predatory behavior by lenders. They included anti-poverty, religious and consumer advocacy groups in the best democratic traditions.

The most obvious example of a federal law that sets a national baseline is the minimum wage. It is applicable everywhere in the United States, but states can raise the amount. For example, Washington State has a minimum wage of $9.04 an hour, well above the national minimum set by Washington, DC, of $7.25.

There are many areas in finance where federal guidelines can lay down a minimum or maximum. For example, regulatory agencies can establish a maximum interest rate on credit cards and personal loans. States can set a still lower one if they choose. They can also take stronger anti-fraud action at the local level, as former Attorney General Eliot Spitzer did in New York. Some states are trying to get public companies to develop long-term objectives and recognize stakeholders other than shareholders.

The difficulty of reaching a federal-state balance became clear in the battle over healthcare. Reformers had originally tried to set national minimum standards for health coverage. The final Affordable Care Act leaves it to the states, which could result in a race to the bottom and lower standards.

The federal government should set baselines for citizenship, economic security and rules of the road for markets because it has the unique ability, and thus responsibility, to do so. The individual states could then focus on how to strengthen those laws and adapt them to their local conditions. This new, progressive federalism would benefit all citizens, and help make government work again.