Feb. 6 (Bloomberg) -- Banker bashing is great sport.

It satisfies the populist need for an identifiable villain in the financial crisis. It provides an outlet for our collective anger. It absolves us from thinking about just how we -- the credit-card-loving, mortgage-craving, debt-addicted consumers of America -- helped foment the meltdown.

It is even useful, when coupled with $500,000 compensation caps, for a president desperate this week to deflect attention from taxing cabinet matters.

The problem is this game of pin-the-blame-on-the-banker gives cover to those who deserve a far greater share of the blame for this crisis -- the people whose job it was and is to set the rules of the game and keep things from getting out of hand.

That would be the government, the Congress and the Federal Reserve, especially former Chairman Alan Greenspan.

Sure, the bankers deserve some blame and punishment. They were greedy and rapacious and stuffed their pockets with as much bonus cash as is humanly possible.

Are we really surprised? Wall Street’s sole reason for being is to make money, the more the better. We always knew that. Pretending otherwise is silly if not disingenuous.

Yet plenty of folks who knew better did just that.

Regulators stopped regulating because they became captives of those they were supposed to oversee. Congress stopped crafting laws that would provide sound rules of the road for markets because members didn’t understand finance and blindly followed supposed experts espousing laissez-faire dogma. The Fed failed to act as the designated party pooper and punch-bowl remover, worrying instead that if it acted too harshly it could stifle innovation.

Behaving Badly

In other words, these folks abdicated their responsibility. And that is even worse than bankers behaving badly.

Consider the Securities and Exchange Commission. When it wasn’t busy missing frauds, the investors’ watchdog was giving the green light for investment banks to borrow suicidal amounts of money to wager on exotic instruments.

This same commission was also more concerned about the cost of internal controls at companies than the price markets would pay if, say, a bank failed to adequately monitor and understand $25 billion parked in some invisible off-balance-sheet vehicle.

Banking regulators, meanwhile, stood mute as banks sold more and more loans as quickly as possible to investors around the world. They never stopped to make sure banks weren’t gutting lending standards in their rush to feed this machine.

Partners to Banks

At the same time, banking regulators cast themselves as partners to banks, rather than the stern disciplinarians we need. The guiding principle for these agencies was “prudential supervision,” an artful phrase that means there are no cops on the beat.

Then there is Congress. Legislators didn’t just pass on the chance to regulate derivatives that have contributed to the meltdown; they went out of their way to bar the Commodity Futures Trading Commission from exercising oversight in this area.

They also made themselves willing champions of anything Wall Street wanted, just so long as the campaign contributions kept flowing.

Then there was the Fed under Greenspan. He set the tone for the debacle now engulfing us, pushing a view that the best form of regulation was essentially no regulation. The markets would take care of themselves, according to the Greenspan doctrine, and risk could be dispersed among investors.

Misguided Thinking

After all, errant behavior would tarnish an individual’s and institution’s reputation, limiting their ability to do business over the long term. This would deter taking on undue short-term risk to make a quick buck.

It’s tough to believe anyone living in the real world actually believed that. Yet here is what Fed Vice Chairman Donald Kohnsaid on the topic as recently as 2005.

“Most asset managers are employees of institutions --mutual fund families, bank holding companies -- that are in the market for the long haul,” he said in remarks to a panel discussion at the Fed’s annual gathering in Jackson Hole, Wyoming. “It is not in their interest to reach for short-run gains at the expense of longer-term risk, to disguise the degree of risk they are taking for their customers, or otherwise to endanger their reputations.”

This kind of thinking was center stage in bringing us to the sorry point we’re at today, and even Greenspan has said he now considers this view mistaken. Bankers, while having plenty to answer for, were just supporting actors.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Reilly at dreilly14@bloomberg.net

Last Updated: February 6, 2009 00:01 EST