In what should be the greatest liberal moment in decades, Barack Obama runs the risk of presiding over a socially and politically devastating triumph of conservative strategy and policy. It won’t happen at the federal level, where a reasonably progressive president and Congress have begun to renew the critical missions of agencies starved by right-wing predecessors who preached a dated and destructive “government is the enemy” mantra. Rather, it will play out in recession-ravaged states, counties and municipalities, where basic services are being eliminated, schools are laying off teachers and what remains of the safety net is being shredded. The crisis is severe, and spreading. And only the Obama administration and Congress can prevent an economic strangulation of state and local governments that would exceed all but the wildest right-wing fantasies.

Battered by an economic downturn that has collapsed tax revenues, struggling to meet demands that rise with each new round of layoffs and foreclosures, and dramatically more restricted than the federal government when it comes to balancing budgets, states (and the county and municipal governments and school districts that rely on them for revenue-sharing) are experiencing a meltdown that threatens not just social services for vulnerable Americans–as Georgia Levenson Keohane describes–but the basic infrastructure of government. The conservative dream of so weakening civil society that public services and schools no longer function is on the verge of being realized in states across the country.

The crisis is not just in California, whose structural pathologies are outlined by Marc Cooper. Officials in four dozen states have experienced their own variations on San Francisco Mayor Gavin Newsom’s realization regarding California’s plight: “It’s the issue that transcends all other issues. You can’t talk about issues in healthcare, education and infrastructure improvement until you focus on the issue of these structural imbalances in the budget.”

Forty-eight of the nation’s states have struggled this year to balance budgets in the face of staggering revenue shortfalls. By quickly and efficiently using desperately needed federal stimulus dollars, most states were able to adopt balanced budgets before their June 30 deadlines. “Without the money from Washington, things would have simply shut down in a lot of states,” says Wisconsin State Representative Mark Pocan, a Democrat who co-chairs his legislature’s Joint Committee on Finance and who has led regional and national networks of progressive legislators. “Even with it, we’ve had to cut back when the needs are more pressing than ever.”

According to the Center on Budget and Policy Priorities, at least twenty-one states have implemented cuts that will make it harder for low-income families and children to get healthcare; at least twenty-two are cutting programs for the elderly and the disabled; at least twenty-four are cutting K-12 and early childhood education; and at least thirty-two are cutting higher education. At least forty-one states and the District of Columbia are laying off or furloughing public employees.

And things are going to get worse, fast. Anticipated revenue shortfalls for the coming years are as severe and potentially worse than what the states have already had to deal with. Even before the current fiscal year is done, several dozen states are likely to see their budgets go out of balance, as revenues continue to hemorrhage. It’s “like breaking your leg and then getting pneumonia,” says Corina Eckl, who directs the fiscal program at the National Conference of State Legislatures.

If the revenue shortfalls weren’t bad enough, states are only now beginning to come to terms with pension fund losses–California’s two largest funds are out by some $100 billion–that started with last fall’s market crashes and have accelerated as thousands of public employees have been driven into early retirement.

For states that have already raised taxes, slashed spending, raided rainy-day funds, furloughed workers and released prisoners to make ends meet, these new challenges will be overwhelming. That might delight conservatives like Grover Norquist, who likes to talk about getting government “down to the size where we can drown it in the bathtub.” But the social consequences are wreaking havoc not just on the poor but on the middle class, especially as school districts implement deep cuts and public-safety forces freeze hiring. The potential consequences for Obama and Congressional Democrats governing at such a chaotic moment cannot be overestimated.

As dire as the circumstances are, it is still possible to stabilize the states. But that won’t happen without federal interventions. President Obama and Congress have far more flexibility than state officials, who operate under tight budget-balancing rules. And they should exercise those options quickly. Recognizing that most of the administration’s long-term goals–particularly healthcare reform–will require functional regional and local partners, Washington should adopt a crash program to stabilize the state economies.

This fall’s appropriations process is the place to start. No matter what happens with healthcare reform, smarter Medicaid reimbursement strategies that reward quality of care and eschew schemes to raise money for new programs by squeezing the states will help states balance budgets and maintain services. Transportation and infrastructure proposals advanced by Minnesota Representative James Oberstar and Oregon Representative Peter DeFazio, both Democrats, will give states more options and create jobs. The education budget, if it can be wrestled away from No Child Left Behind dead-enders, can be used to help states and school districts keep teachers on the job. And the Obama administration and its Congressional allies should use this budget to renew the revenue-sharing programs killed by the Reagan administration in order to starve state and local governments.

Even with smart budgeting and state-friendly policy shifts, however, it’s likely that another stimulus will be necessary. But the much-discussed “second stimulus” will work only if it is firmly focused on the priorities of job creation–which helps states already experiencing double-digit unemployment generate new tax revenues while easing social-service demands–and direct aid to state, county and municipal governments.

Banks and financial institutions were never “too big to fail.” State and local governments are. The president and Congress must concentrate their energies on averting government failures that would devastate states and communities–and put “change we can believe in” out of reach.