Wall Street whiners

(Fortune Magazine) -- Given Wall Street's meltdown, it comes as no surprise that many normally reasonable people would love to bind and gag the financial industry in red tape.

Politicians such as Representative Barney Frank (D-Mass.) and Senator Charles Schumer (D-N.Y.) are calling for new rules. The Treasury has circulated a blueprint for a sweeping new system, but even though the plan includes a radical expansion of the Fed's powers, critics say it doesn't tighten regulation enough."

The great irony: Until now, Wall Street, with the help of the broader business community - and some of those very same politicians - was angling for less regulation. Around this time last year, reports studded with blue-chip names argued that too many rules were partly responsible for the decline of the U.S. empire. "The pendulum of regulation in the U.S. has swung too far in recent years," said the "vast majority" of those surveyed by McKinsey & Co. - whose report, by the way, was backed by New York Mayor Mike Bloomberg and, yes, Senator Schumer.

But if you read the reports before consigning them to the garbage bin, you'll discover that they do yield some insights - not all of them intentional. Here's one: The goal should be better regulation, not necessarily more. There's already a morass of rules.

Bloomberg and Schumer, in an editorial they co-wrote, pointed out that there are multiple federal, state, and industry regulatory bodies in the United States, and the gross financial regulatory costs to U.S. companies are 15 times higher than in Britain. In 2005, the last year for which data are available, the securities industry spent $25.5 billion complying with regulatory and legislative mandates, says the Securities Industry Association. Securities firms also report on average almost one regulatory inquiry per trading day, and large firms experience more than three times that level, said McKinsey.

In their zeal to tally up all this, though, the various authors completely missed the opportunity to think critically about where innovation might have gotten ahead of regulation. In today's harsh light, their blithe attitude seems astonishing. For instance, McKinsey wrote that over-the-counter derivatives "help foster the kind of continuous innovation that contributes heavily to financial services leadership." (Tell that to Bear Stearns (BSC, Fortune 500).) McKinsey also complained that higher capital requirements for U.S. banks would put them at a "competitive disadvantage." (Hello, Citigroup (C, Fortune 500)!)

The reports, of course, complain about the onerous nature of Sarbanes-Oxley, which, as you may recall, was enacted to restore investor confidence after little hiccups like Enron and WorldCom. But the authors missed the bigger problem. Whether you agree or disagree with SarbOx, it turned out to be perfectly irrelevant to the current crisis.

On that note, think too about the rules that were supposed to make it harder for companies to stash things off their balance sheets. In response, we got SIVs in the shadows. Regulation in today's fast-moving markets often seems to be a perfect example of Maginot Mentality. We build fortifications to stop the Germans - or in this case, the business world's "innovations" - only to have them go around the line and destroy us from another direction.

The various reports may have gotten one big thing right: Many argued that a broad, principles-based approach to both accounting and regulation would work better and cost less. But living according to principles requires a certain maturity and a long-term view of where one's self-interest lies. Right now, Wall Street seems like a child who can't keep his hand out of the cookie jar, even when the cookies are going to make him sick.