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How did we get into this mess? The story is remarkably similar to the tale of subprime mortgages. Lenders who were making money by putting the loans into pools became more and more eager to make loans, and less and less concerned about their quality.

The way the loan securitization market developed, the most profitable loans to make were those rated B or even B-minus, levels of debt below the old standard for most junk bonds. There was a market for some Caa paper, even though such loans historically often landed in default.

Borrowers who ran into problems could refinance their debt, creating new rounds of fees for the banks making the loans and obscuring the problems with credit. And with the economy booming, there were not that many problems anyway.

The secret to all this was the collateralized loan obligation, or C.L.O. As with mortgage securities, the rating agency models figured that 70 percent of the money that went into financing single-B rated loans could be financed with AAA-rated paper.

As time went on, the big banks making the leveraged loans became more and more competitive, figuring the secret to profits was in making the loans and securitizing them — not necessarily getting them paid back. It was financial alchemy, but the AAA-rated paper was popular with buyers like banks and insurance companies, whose capital rules treated such securities as virtually risk-free. They wanted more such paper, and the big banks obliged.

“C.L.O.’s bought about two-thirds of corporate loans from 2004 to 2007,” said David Preston, a structured products analyst at Wachovia Securities. But there are now no new C.L.O.’s being created, and many of the old ones may soon be barred from reinvesting repayments in new loans — in part because so many existing loans are being downgraded by the rating agencies.

At the height of the lending mania in early 2007, the banks were offering “covenant-lite” loans, meaning that they would not go into default just because the borrower ran into financial problems that caused it to fail to meet some covenant, perhaps requiring a minimum level of earnings. And the banks offered what was called “toggle-PIK,” which gave the borrower the option to pay the interest by increasing the amount owed, rather than by putting up cash.

If a company can default only by not paying the interest, and it is not required to pay the interest in cash, defaults are unlikely, at least until the PIK period ends or the company is unable to meet some other obligation.

The loans were the corporate equivalent of the now-notorious pay-option mortgage loans, where the borrower could choose to pay only a fraction of the interest, adding the rest to the amount he owed.

Last month, Mr. Cuomo’s office brought a 123-count indictment against two aides to the former state comptroller, Alan G. Hevesi, accusing them of selling access to the state’s $122 billion pension fund and reaping millions of dollars for themselves. The two aides are Hank Morris, who was Mr. Hevesi’s top political consultant, and David Loglisci, who was the chief investment officer of the pension fund.

The S.E.C. brought a parallel action against the two aides, accusing them of violating several securities laws. Lawyers for Mr. Morris and Mr. Loglisci have adamantly denied wrongdoing on the part of their clients.

Mr. Wissman is described as having played a major role in encouraging the state pension fund to expand into hedge funds. The S.E.C. complaint brought against the Hevesi aides last month said that a hedge fund manager affiliated with HFV, then identified only as “Individual A,” paid Mr. Morris “in exchange for causing the Retirement Fund to expand its investment portfolio to include hedge funds” and to make the Hunt fund one of the first to attract state money.

The latest court filings make clear that “Individual A” is Mr. Wissman.

Mr. Wissman’s guilty plea is specifically related to his role in facilitating pension investments for Access Capital, a European company that markets a so-called fund of funds — an investment fund that invests in a variety of private equity firms.

According to new court filings released on Tuesday, Mr. Wissman helped Access win more than $500 million worth of business from the New York State pension fund and was rewarded with $1.5 million in fees. But according to the felony complaint, he misrepresented to Access how he was getting the business.

While he told the company he would not share his fees with a third party, he did just that, court records say. He was paid $2.4 million and “then secretly transmitted approximately 33 percent of that amount, more than $790,000” to two firms affiliated with Mr. Morris, according to the S.E.C. complaint.

According to the court records unsealed Tuesday, Mr. Wissman “engaged in fraud, deception, concealment” and “made material false representations and statements with intent to deceive and defraud.”

By September 2004 Beal Bank's assets had climbed to $7.7 billion. Then Beal stopped buying, letting his loans run off. By September 2007 assets had shriveled to $2.9 billion, one-fifth of which was cold cash. He was worried that consumers had taken on too much debt and money was being lent to companies for next to nothing. "Every deal done since 2004 is just stupid," Beal says.

He began by pulling back from home loans--even those guaranteed by Fannie Mae

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) and Freddie Mac

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). Beal thought the two quasi-government agencies were over-leveraged. When staffers mentioned their guarantees in deal presentations he would fire back that these guarantees were "worthless."

Then came the summer of 2007, and Wall Street's securitization machine began to break down. Prices on pools of mortgages were falling. Beal was tempted but insisted on inspecting individual loan files. Wall Street refused. Still, he knew his time was coming. To prepare bids he locked himself in his office to write a computer program with 50 variables (now 250), ranging from home price changes by neighborhood to interest rates to origination dates.

By 2008, Wall Street started letting Beal peel off individual loans. He bought a bit, then in earnest when Bear Stearns collapsed. He concentrated first on whole single family residential loans, buying $1.8 billion of those. He has hired 160 people to service residential mortgages, arranging the employees in rows of cubicles one floor below his office. His payroll has more than doubled to 450.

Lately he's been spending on a broad range of assets. Beal just bought a $465 million loan to bankrupt chemical maker Lyondell. He's extended tens of millions to utilities, manufacturers, convenience stores, hotels, casinos--"everything you can imagine, in every state," he says. Many of those assets have come from 15 failed banks, including First Integrity in Minnesota, Arkansas National and First Priority in Florida. Since November he's bought $2 billion (face value) of home loans bundled into securities, too. But he says he's still just picking off loans with a "rifle" not a "shotgun," buying only 3% of what lands on his desk while waiting for the financial system to further "unravel."

He says Treasury Secretary Timothy Geithner's new plan to guarantee loans to buyers of toxic assets won't lead to many sales because the problem isn't liquidity but price. They are not low enough. Half the country's banks--4,000 in all--would be bust, he says, if they marked their loans to what the loans would fetch in an auction. He says banks are fooling themselves by refusing to mark busted assets down.

"Banks are on a prayer mission that somehow prices will come back and they won't have to face reality," Beal says. And that reality, according to Beal, is going to get a lot worse. "Unemployment is going over 10%, commercial real estate hasn't even begun collapsing and corporate credit defaults are just getting started," he says. His prediction: depression, without bread lines this time, thanks to the government safety net, but with equal cost to society.

The greed narrative leads to the conclusion that government should aggressively restructure the financial sector. The stupidity narrative is suspicious of that sort of radicalism. We’d just be trading the hubris of Wall Street for the hubris of Washington. The stupidity narrative suggests we should preserve the essential market structures, but make them more transparent, straightforward and comprehensible. Instead of rushing off to nationalize the banks, we should nurture and recapitalize what’s left of functioning markets.

Both schools agree on one thing, however. Both believe that banks are too big. Both narratives suggest we should return to the day when banks were focused institutions — when savings banks, insurance companies, brokerages and investment banks lived separate lives.

We can agree on that reform. Still, one has to choose a guiding theory. To my mind, we didn’t get into this crisis because inbred oligarchs grabbed power. We got into it because arrogant traders around the world were playing a high-stakes game they didn’t understand.

Economists at Goldman Sachs estimated recently that banks were valuing their mortgages at about 91 cents on the dollar, far more than investors are willing to pay for them.

Even though the Treasury Department plans to subsidize the purchases of toxic assets by giving buyers low-cost loans to cover most of their upfront cost, a growing number of analysts warn that many if not most banks will remain reluctant to sell.

“The gap is still very wide,” said Frank Pallotta, a former mortgage trader at Morgan Stanley, now a consultant to institutional investors. “If every bank was forced to sell at the market-clearing price, you’d have only five banks left in the market.”

The stress tests of the banks are aimed at estimating how much each bank would lose if the economic downturn proved even deeper than currently expected.

Government officials do not plan to disclose the results for individual banks but may reveal broad results for the entire industry at the end of the month.

If the test indicates that the losses would leave a bank with too little capital, the bank will have six months to either raise extra money from private investors or get money from the government. Executives at some banks are worried that regulators will start demanding changes in management and strategy, possibly forcing them to merge with stronger institutions.

Both large and small banks have pressed the Obama administration to make it less costly for them to exit the bailout program by waiving the right to exercise stock warrants the banks had to grant the government in exchange for the loans. At a meeting last month, the chiefs of three of the largest banks separately asked Mr. Obama to direct the Treasury not to exercise the warrants, Mr. Fine said.

Douglas Leech, the founder and chief executive of Centra Bank, a small West Virginia bank that participated in the capital assistance program but returned the money after the government imposed new conditions, said he complained strongly about the Treasury Department’s decision to demand repayment of the warrants. That effectively raised the interest rate he paid on a $15 million loan to an annual rate of about 60 percent, he said.

“What they did is wrong and fundamentally un-American,” he said. “Even though the government told us to take this money to increase our lending, the extra charge meant we had less money to lend. It was the equivalent of a penalty for early withdrawal.”

“This is an opportunity to forge an alliance between Main Street, Wall Street and K Street,” said Steven A. Baffico, an executive at BlackRock, referring to the Washington address of many lobbying firms. BlackRock, a giant money management firm, is playing a central role in the government’s efforts and is considering creating a bailout fund. “It’s giving the guy on Main Street an equal seat at the table next to the big guys,” he said.

“They are getting taxed for this problem. They should have an opportunity to participate in the recovery.”

Still, it is unlikely that everyday investors would play a major role in financing the bailouts through these funds. Hedge funds and other private investment firms are expected to invest far more money. The Treasury has not said how much money it intends to raise from individuals; first it wants to select about five fund managers to participate in the program to buy beaten-down securities. These firms must demonstrate an ability to raise about $2.5 billion among them.

To head off the political risk of using public subsidies to move the assets from banks into the hands of private investors, the Treasury has already announced that, as part of its plan, it will retain part ownership of the toxic securities and loans, thus ensuring that taxpayers will share some of the gain if the assets’ prices rise.

But the comparison one industry official uses to illustrate the mistake that America must avoid is the large-scale privatization in Russia in the 1990s, which involved a transfer of entire industries to a few, well-connected oligarchs. That experience tarnished the idea of free-market capitalism in Russia and undermined its program to move toward a market economy.

“It is really, really important to allow Main Street in,” said the official, who was involved in discussions about the plan but who asked for anonymity because he was not authorized to speak about it publicly. “They are getting taxed for this problem. They should have an opportunity to participate in the recovery.”

Perhaps more important than the money would be the political bonus of having thousands or even millions of taxpayers — whose portfolios have nose-dived during the crisis and whose tax dollars are financing bank bailouts and stimulus packages — profit from the toxic asset plan.

As well as BlackRock and Pimco, Legg Mason, another big mutual fund company, and BNY Mellon Asset Management, a big asset manager, have said they are interested in starting retail investment funds to participate in the government’s plan.

For the investment managers, the benefits are potentially large. These big firms can charge healthy fees to investors for taking part.

As part of the tests, the banks analyzed each category of loans they held and compared their results with the “high” and “low” range of government loss estimates. If a bank expected fewer losses than the government, the regulators asked the institution to explain why.

The banks were also asked to project their earnings over the next two years to give the regulators a better sense of how much capital they would have to absorb the coming losses.

Several people involved in the process say there is a wide range of results among the institutions. Those that fall short will have six months to raise capital from private investors; if they are unable to do so, the Treasury Department has said taxpayer money will be available.

Some federal and industry officials say regulators may use the results to prod reluctant banks to sell assets under that program.

At a recent breakfast with a dozen or so corporate and banking executives in New York, Treasury Secretary Timothy F. Geithner warned he would take a tough stance. Many banks, he suggested, believe the investments and loans on their books are worth far more than they really are, according to a person who attended the meeting.

Mr. Geithner said that was unacceptable. The banks, he said, will have to sell these assets at prices investors are willing to pay, and so must be prepared to take further write-downs.

So what can be done to prevent a repeat? Financing regulatory agencies at least partly through Congressional appropriations rather than user fees might help cut the ties between industry and regulators. It’s no panacea, though.

The predecessor to the O.T.S. was abolished precisely because lawmakers leaned on regulators, threatening to cut their budgets, to stop an investigation into Lincoln Savings and Loan, the institution controlled by Charles Keating that subsequently failed. But at least the distance between regulator and regulated is greater when funds come from Congress.

t's awfully hard to crack down on these people when you are fairly begging them to come to your new government-guaranteed casino.

Even more alarmingly, the administration is now using the Federal Reserve as an unlegislated, all-purpose slush fund.

What we have is something perilously close to a dictatorship of the Fed and the Treasury, acting in the interests of Wall Street. The contrasts with the first hundred days of the Roosevelt administration are striking. Like Roosevelt, Obama faces an economic emergency. Like Roosevelt, he faces an angry public, which has been bilked by excesses on Wall Street. And like Roosevelt, Obama has a supportive Democratic Congress that is willing to substantially defer to the White House on an emergency recovery plan.

But unlike Roosevelt, who used the public's indignation and Congress's support to constrain the barons of private finance, Obama's economic team is using government funds to put the most abusive players on Wall Street back in the saddle. And Geithner and Summers, working with the Fed, are assembling their plan with no public scrutiny.

Until last September, the Fed bought and sold mainly Treasury bonds, the safest securities there are. And it did so for one purpose only--to conduct monetary policy. Now, the Fed is buying trillions of dollars of junk assets, and it will be under tremendous pressure to keep these on its own books, compromising its capacity to run the nation's monetary policy.

It's possible that the Geithner plan will "work" in the sense of re-starting the Wall Street bubble machine, this time with a limitless line of direct credit from the Federal Reserve. If that happens, it will defer an even more serious day of reckoning, as the cost of the Fed's immense credit creation comes due. But the greater likelihood is that the plan will merely enrich some speculators, but neither bring zombie banks back to life, nor get a normal banking and credit system operating again. And then the administration will need to come back to Congress, this time with less credibility, with the economy in even worse shape, having burned through more than a trillion dollars.

How can one crash that wipes out $10 trillion in assets cause no damage to the financial system and another that causes $3 trillion in losses devastate the financial system?

The events of the past 10 years have an eerie similarity to the period leading up to the Great Depression. Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth.

The Great Depression has been attributed to excessive speculation on Wall Street, especially between the spring of 1927 and the fall of 1929. Had the difficulties of the banking system been caused by losses on brokers' loans for margin purchases in 1929, the results should have been felt in the banks immediately after the stock market crash. But the banking system did not show serious strains until the fall of 1930.

Bank earnings reached a record $729 million in 1929. Yet bank exposures to real estate were substantial; as the decline in real estate prices accelerated, foreclosures wiped out banks by the thousands. Had the mounting difficulties of the banks and the final collapse of the banking system in the "Bank Holiday" in March 1933 been caused by contraction of the money supply, as Milton Friedman and Anna Schwartz argued, then the massive injections of liquidity over the past 18 months should have averted the collapse of the financial market during this current crisis.

The causes of the Great Depression need more study, but the claims that losses on stock-market speculation and a monetary contraction caused the decline of the banking system both seem inadequate. It appears that both the Great Depression and the current crisis had their origins in excessive consumer debt -- especially mortgage debt -- that was transmitted into the financial sector during a sharp downturn.