Oct. 5--To clean up the financial mess we're in, we need a solid understanding of how it started. On that score, most of our leaders seem clueless.

Let's sweep away the myths they are putting forward, and then see if we can come to some clear-headed conclusions about why things got so bad.

The first myth, a favorite theme among Democratic politicians, is that deregulation allowed banks and securities firms to take excessive risks. Former Sen. Phil Gramm, a Texas Republican who sponsored 1999 legislation that erased the barriers between commercial banking and investment banking, is usually the villain in this story.

Failed investment firms such as Lehman Brothers and Bear Stearns, however, had no significant commercial-banking operations. Meanwhile, the bankers at Wachovia and Washington Mutual got into trouble by making bad mortgage loans. That's a business they've always been in, so it's hard to see how deregulation played a role.

Gramm's legislation, in fact, is proving to be part of the solution. JP Morgan Chase, a commercial bank, bought what was left of Bear Stearns, and Bank of America rescued Merrill Lynch. Those deals wouldn't have been possible if the Depression-era Glass-Steagall Act was still in force.

Other elements of banking deregulation have helped reduce risk. If we didn't have interstate banking, we'd see many more bank failures in states like Florida and California.

Republicans, meanwhile, have favorite myths of their own. One is to blame the subprime mortgage crisis on speculators, those greedy folks who flipped Florida condos for profit or took out "liar loans" on houses they knew they couldn't afford.

Those cases exist, to be sure, but for every conniving condo-flipper there are dozens of ordinary homeowners who were suckered into loans they didn't understand. They're the victims here, and blaming them for bank failures is like telling the Titanic's passengers that they brought too much luggage onboard.

What about those complex derivatives that brought down insurance giant AIG? It's easy to denounce something you don't understand, but credit-default swaps and other complex instruments are merely tools. They can be used to decrease risk or to increase it. AIG overdosed on them, but outsiders didn't know how exposed the company was. The problem wasn't with the instruments themselves, but with a lack of disclosure and transparency.

My least favorite piece of mythology, heard on both sides of the political aisle, is the charge that this crisis was caused by greed.

This one is actually true, after a fashion. Without greedy bankers and house buyers and investors, we wouldn't have had a housing bubble. We also wouldn't have an economy, because the capitalist system is based on greed. The market will always need self-interested human beings.

If we can't blame this crisis on deregulation or derivatives or speculators or greed, then what are the real bogeymen? I'll offer two: excess liquidity and crony capitalism.

What we're living through is the bursting of a bubble. In response to the 9/11 terrorist attacks, the Federal Reserve kept interest rates unusually low throughout 2002, 2003 and 2004. It was essentially injecting money into the banking system to keep the economy's gears moving, even though the economy emerged from recession in November 2001.

Much of that excess liquidity, we now know, went into house mortgages. In part, the rapid increase in house prices was classic, myopic bubble behavior. House prices hadn't fallen in more than a generation, so people began to believe that they could only go up.

The housing market also had some key players who weren't subject to normal market discipline.

The hotbed of crony capitalism was in Washington, where Fannie Mae and Freddie Mac hired legions of lobbyists to ensure that they could take on a lot of debt, expand like crazy and pass the real risk on to taxpayers. If these giant companies had been regulated like private banks, today's mortgage mess would be much less severe.

The crony system operated on Wall Street, too. The masters of the universe who created the subprime mortgage market were compensated for volume, with no consideration for the risk they were creating. Boards of directors signed off on this pay, and then watched their companies be destroyed.

The boards need to be made more accountable, either by allowing shareholders to vote on pay packages or by making it easier for them to throw out directors.

In short, what we need isn't less greed or more regulation but a purer form of capitalism. If we can root out cronyism wherever it exists, the free market may yet stand a chance.

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