(FORTUNE Magazine) – Once upon a time, there was an economy so wonderful that it seemed to have come from a fairy tale. Inflation was low, unemployment was low, growth was strong. Everyone's income began to rise, and there were fewer poor. People were happy and gave lavish holiday gifts; they also gave lots to charity. Foreigners liked the economy so much that they poured more and more money into it. This happy state of affairs--call it the Goldilocks economy--encouraged, or at least occurred at the same time as, other nice things. Crime rates fell, making everyone feel safer. Even the inhabitants of Gotham were alleged to have become warm and cuddly (though there were many doubters about that!). Fewer teenagers considered having babies a good idea. More people said their marriages were happy. The kindly wizard whose monetary potions got much of the credit for this magical period called this era "history's most compelling demonstration of the productive capacity of free peoples operating in free markets." Gosh!

Many clever people thought this glorious time would last forever because of an ethereal Good Fairy called the New Paradigm. But it didn't. And that was too bad. Because instead of making hay while the sun shone, or storing nuts against the rigors of winter, or acting out other useful metaphors of providence, the inhabitants of the Goldilocks economy did no such thing. Maybe they were too busy shopping. And when economic winter came, they were not prepared. Thus, they did not live happily ever after.

Is that a plausible ending to the tale of the Goldilocks economy? Unfortunately, yes. February marks the month when the current expansion, which began in March 1991, officially becomes the nation's longest. But that does not mean that it is destined to last forever. And in important ways, America has not taken the opportunity of this long upturn to prepare for the next downturn. We will suffer more when the economy slips--as it will--because we have not made the structural adjustments that would have allowed us to ride through a bit of turbulence with grace.

Indeed, when Americans look back at this period during the recession of 2020 (brought on mostly by having to finance the retirement of the baby-boomers, who are refusing either to work or to die), they are going to kick themselves. Why didn't we save more? Why didn't we get a grip on our government? How could we have let so many obvious problems go unaddressed? Why weren't we smarter with our outrageous fortune? Here are a few of the things that our future selves will regret.

--Health care: Remember health-care reform? Bill and Hillary's big plan got knocked out of Congress in 1994. At the time, the Democrats vowed to come back to the subject. So did the Republicans. But the issue pretty much disappeared from sight until last summer--right before a new presidential election season. Funny, that.

What isn't funny is that the problem has gotten much worse. In 1994, before the boom really started, 39.7 million Americans lacked health insurance; by 1998, when the good times were rolling, more than 44 million (16.7%) were without it. The poor or near-poor, of course, are the most likely to go without; a third of Americans with incomes below the poverty line are uninsured. But the problem is also creeping up the income ladder. According to the National Journal, 20% of the uninsured live in households making $50,000 or more a year. That suggests that the number of uninsured has not yet peaked; by 2007, according to some of the gloomier projections, the proportion could reach 25%.

And then there's the other half of the health problem--the group that is guaranteed insurance. Medicare, for those over 65, is in much bigger trouble than the other mega-entitlement program, Social Security, whose costs are high but predictable. Sure, Social Security is still a bad deal, but a bankruptcy date that is 30 years off ain't too bad. The costs of Medicare, on the other hand, are both rising and unpredictable; the program could be bankrupt before the decade is out. Almost the entire "peace dividend" (the drop in the defense budget) since 1989 has gone into federal spending on health. So naturally Congress and the President are falling all over themselves to create new Medicare benefits.

--Household finance: The death of the savings rate has been greatly exaggerated. Last year the government's bookkeeper, the Bureau of Economic Analysis, released new, improved estimates of what the nation makes, spends, and saves. So forget what you've heard about Americans' now saving less than zero of their disposable income; in fact, in 1998 we saved about 3.7% and in November 1999 were saving about 2.2%. What is true is that the trend in saving is down, from a high of 10.8% in 1981. Is this a problem? Yes and no. No, because the national savings rate, 18.8%, is higher than it's been since 1982, now that the federal government is no longer a borrower. But yes, there is the glimmering of trouble here.

For a start, the U.S. is relying heavily on borrowing from abroad; the current-account deficit has reached about 4% of GDP. If our friends lose their appetite for dollars, we will not be able to make up the difference, given our meager savings rates. That would spell trouble. At the very least, the Fed would have to raise interest rates to coax investors to keep their dollars.

At the moment these are still theoretical problems; a very real problem, however, has to do with debt. Overall, more than one in eight U.S. households (and a third of those making less than $10,000) has debt payments of 40% or more of income--the level where debt is considered burdensome. That is a striking 17% increase since 1995. Among families with debt, the median amount has risen more than 40% over the same period. Credit card delinquency rates and personal bankruptcies rose to record levels in 1996-98; both slowed in 1999 but remain high.

At one level, these trends are the result of the democratization of credit, which has allowed more households to balance consumption and spending, with good effects on both living standards and the economy as a whole. But it is clear that too much credit has been extended to too many people with bad or no credit histories. In the mid-1990s, in particular, credit card companies were soliciting new customers with something like frenzy. "Subprime" debt--that is, credit extended to risky borrowers --has zoomed from $62 billion in 1993 to almost $400 billion now, and defaults are rising fast. High loan-to-value credit, typically extended to risky borrowers, has risen from less than $1 billion to more than $25 billion over the same period.

At the upper end of the income ladder--above $50,000 a year--debt levels have risen slightly but are still reasonably low. However, at the bottom half of the income distribution, people are indeed spending more than they earn and covering the gap through borrowing. If you think this doesn't matter because of rising stock portfolios, sorry. First, notes Mark Zandi of Regional Finance Associates, margin debt--borrowing to buy stock--is rising fast, more than 60% in 1999 alone. Any downturn in the market, then, could actually increase indebtedness in some stock-owning households, as well as drive down share prices further. And second, only about half of American households own stock, and they are overwhelmingly the richer half (see box). In other words, the people most likely to be getting into a troubling degree of debt are the least likely to have stock assets.

The current situation in too many households--high debt, middling earnings, and low savings--is unsustainable, and getting worse. "There is never going to be a better time to repair balance sheets," says Zandi, "because at some point in the not too distant future, things will not go as well as in the recent past." When that happens, indebted, unrich households are going to be hurt worse than they need to be.

That will be a personal trauma for many families. The economy as a whole will also suffer. Any downturn will lead hard-pressed homes to slow their spending. With consumption accounting for two-thirds of GDP, that contraction will ripple throughout the economy. Moreover, with debt, bankruptcy, and delinquency at such high levels in an era of prosperity, they can be expected to go higher during a recession. That will take a toll on banks and lending companies and make it that much more difficult, in turn, to pull ourselves out of recession. The bottom line is that thrift is not just a tedious Puritan virtue but an economic one that Americans will rue dissing.

--Government reform: President Clinton declared that the era of big government was over; Al Gore promised to reinvent the government; and Newt Gingrich to revolutionize it. Yeah, right. The federal government has not changed in any important way, except by getting bigger. The 1999 budget, approved in November 1999, hit $1.8 trillion--more than the entire French economy. This is a bipartisan achievement. In the 1999 budget, even the Republicans could not come up with a single program anywhere in its thousands of pages that should be killed. Remember the spending caps that were supposed to, well, cap spending? They got lost in a blizzard of "emergency" appropriations; in fiscal 2000, such emergencies will cost about $30 billion.

It's true, of course, that the federal books look better than they have in years. But the red ink has turned black not because of any restructuring, rethinking, or reinventing. The surplus has resulted from higher than expected tax revenue, which has resulted from faster than expected growth. When growth slows, the surpluses will at least diminish and quite possibly vanish, given our proven inability to cut spending. At the moment, though, the U.S. has entered a kind of budgetary twilight zone, in which surpluses are spent in fantasy budgets before they even exist. The mind reels when serious people--some of them running for President--discuss how to spend the surplus of 2014.

Whether one thinks the government should be bigger or smaller than it now is, there really can be no disagreement that it should be no larger than it needs to be and that it should not be stupid. Which brings us to corporate welfare--direct taxpayer assistance to specific businesses or industries. One might think that in an era of unprecedented prosperity, stock market valuations, and profits, America's corporations could live without sucking Uncle Sam's teat. And politically this seems like a no-brainer. No left-winger worth his Birkenstocks wants to subsidize Big Business, and the right is supposed to favor a cheapskate government. Somehow, though, that has not translated into even minor jabs at the corporate welfare state.

In November 1998, Time magazine estimated a total of $125 billion of such idiocies--ethanol subsidies; sugar price supports; grants to Silicon Valley giants for product development; payment for companies' basic research and overseas advertising; the purchase of weapons systems that the armed forces do not want; and blatant giveaways to the tobacco, nuclear, coal, and electricity industries. (Time's estimate includes state programs; other estimates just of federal aid are in the $60 billion to $70 billion range. And yes, Time Warner, FORTUNE's parent, has scarfed its share.) In some ways, things have gone backward; though the Freedom to Farm Act of 1995 prodded agriculture closer to free-market norms, there has been a huge increase in subsidies since.

And that's just the feds. The states are also busily not changing corporate welfare as we know it. The people of Missouri, as they celebrate the Rams' victory in the Super Bowl, have paid for their football pleasures through hundreds of millions of dollars in concessions to lure the team from Los Angeles. The bidding war for new jobs and factories continues with familiar ferocity--and no net gain to the economy. Corporate welfare is bad because it distorts markets, favors large over small companies, politicizes business--and does not even generate good returns on investment. If we can't get rid of this nonsense when we are flush, the chance of doing so when the going gets tough looks grim indeed.

--Tax reform: What tax reform? That's the point. In 1991 the top rate was 31% and the tax code, with its associated regulations, was less than seven million words, according to the Tax Foundation. Now the top rate is 39.6%, and there are almost 8.5 million words. The commonly used 1040 form is only two pages long--but comes with more than 100 pages of instructions. Understandably concerned that they will never understand the tax system, more than half of Americans now resort to paid tax preparers. Overall, we spend perhaps $250 billion a year just to file, pay, and avoid taxes. This is wealth that could be used much more productively--and, of course, more enjoyably.

--Monetary policy: It is a strange time indeed when a Delphic, nerdy, elderly civil servant becomes a national icon: Welcome to the Age of Greenspan. Much as we love Alan Greenspan, though, the man will not be at the Federal Reserve forever. Why not, then, attempt to institutionalize his legacy, by formally declaring inflation targeting as the Fed's highest priority?

The case in favor of announcing a numerical inflation target starts with the premise that it is useful for an institution to know what its purpose is. "We don't tell policemen just to administer justice; we give them explicit guidelines," notes N. Gregory Mankiw, a Harvard economist (and FORTUNE columnist). "An inflation target provides a framework for monetary policy decisions, the same way laws give a framework for judges." Second, an inflation target would provide cover for the Fed when Congress tries to pressure it to do dumb economic things for short-term political advantage. Finally, an explicit commitment would reassure businesses that they can concentrate on putting out good products without having to worry about hedging inflation.

The argument against a formal declaration is that it could limit the Fed chairman's flexibility. But an inflation target is a goal, not a fixed number to be met every month on pain of death. And having a target could actually increase flexibility. The Fed might be less skittish, for example, about easing monetary policy if it could be confident that the markets would not interpret such actions as an invitation to inflation.

Inflation targeting is not a monetary panacea. The Fed will always need people of judgment and integrity. But the policy could help to shield the institution against pesky political munchkins. And it makes sense to do this now, at a time when the Fed enjoys unprecedented prestige. "Does Greenspan need an inflation target to help him do his business?" asks Frederic Mishkin, a former economist at the New York Fed and now a professor at Columbia's business school. "No. But the real issue is, someone else may need this."

--Stupid mergers: Corporate America could have used the unprecedented run-up in stock prices to deleverage its balance sheet or build a cushion against the next twist in the business cycle. Many companies have done just that. But the second half of the 1990s also saw M&A activity on a scale that made the 1980s Predators' Ball look like a clambake. There's just one problem. Most of these deals have failed to earn back their cost of capital. "Shareholders of acquiring firms routinely lose money right on announcement of acquisitions. They rarely recover their losses," concludes Mark Sirower in his book The Synergy Trap. "But shareholders of the target firms, who receive a substantial premium for their shares, usually gain." Conseco-Greentree, First Union-CoreStates, and the notorious Rubbermaid-Newell--the list of disastrous 1990s mergers could fill the page. And there have been lots of less famous ones. In 1994 there were 7,575 mergers and acquisitions, with a value of $342 billion; in 1999 there were almost 11,000 M&A's, worth $1.7 trillion. Merger mania has also played a role in a larger issue: the record level of corporate debt, which has reached 45% of GDP. With corporate defaults rising already, many companies will be hard-pressed financially if a downturn comes too soon.

Maybe America's corporate chieftains got excited at the '90s buzz and wanted to be part of it. Or maybe they just screwed up. Whatever the case, M&A '90s-style has typically meant buying a company at the peak of its market value, then adding a healthy premium. Corporate decision-making has also been impaired by the trend toward using pooling accounting rather than purchase accounting. The pooling option is available only when stock is the currency that changes hands in the deal, and it has the magical effect of making financial ratios look better than they would in purchase accounting. That's because the assets of the acquired company appear on the books of the new colossus at historical cost only; the difference between that fictional accounting value and the actual price paid in the acquisition simply vaporizes.

In real life, of course, the difference still exists in the form of massive dilution: Big pooling acquisitions mean lots of new shares get exchanged for assets priced at a steep premium. Only rarely does the surviving company get enough of an earnings boost from the combination to justify the inflated price and make the deal pay. No wonder the market has regularly flipped the bird at such corporate strategizing. Unsuccessful mergers destroy value, suppress competition, cost jobs--and make a lot of work for lawyers. Those are all bad things for the economy.

Well, when the sun is shining, who carries an umbrella? A sense of urgency is often required to force real change. Britain accepted decades of underperformance and only undertook serious (and unpopular) reform after the "winter of discontent" in which a grave-diggers' strike literally left the dead unburied. The case for change can be difficult to make when times are good.

But it is worth remembering that times are not necessarily rosy for everyone. Rising housing prices have meant that struggling households are ever less likely to find a home within their means. (The response from Congress: refusing to authorize new housing subsidy vouchers for four straight years.) Exactly as many children lived in extreme poverty in 1998 as in 1991. Real median incomes have only recently passed their 1989 peak. And we are all working more hours than we did a generation ago.

Besides, feeling flush is no excuse for failures of imagination and wisdom. Medicare is an entirely predictable catastrophe in the making. No one can argue that the federal budget process is a good one. Too much debt is bad. And so on. If America continues to ignore the economic wolves lurking in its future, this historic expansion could end as one grim fairy tale indeed.