All major financial crises are, at bottom, political crises. Market meltdowns, bubbles bursting, charges of corruption all reverberate back through our political institutions. This certainly occurred in the Great Depression, which altered the political and financial landscape for generations. The bursting of the Japanese bubble in the '90s triggered a broad debate over the relationship between state and private enterprise, knocking the props from beneath the ruling party and producing years of soul-searching and reform. The Russian default of the late '90s may have accelerated the Vladimir Putin-led state control over the economy. And now we have the mortgage meltdown, which after more than a year of preliminaries, has erupted into public consciousness and moved from regulatory reaction to legislation. The hammer beat of events that produced the failures of Lehman Brothers Holdings Inc., the bailouts of Bear Stearns Cos., Fannie Mae, Freddie Mac and American International Group Inc., the transformation of Morgan Stanley and Goldman, Sachs & Co. into commercial banks and the Federal Reserve's decision to open up banks to private equity are all backdrop to the drama of Congress wrestling with a massive mortgage bailout plan on a perilously tight deadline under the looming shadow of a presidential election.

It doesn't get much more political than that.

This is no longer a test of our financial system, including our regulators; it's now final-exam time for our political leaders. Behind the hearings and commentary, the questions and negotiations, are difficult issues that look back -- how did this happen, how did we get here? -- and peer forward: How do we fix what ails us and rebuild the system so it never happens again? (Well, only a fool or a politician says never.) Throughout last week, the details of the Paulson plan came under withering crossfire: Does the government take stakes in companies it helps out; limit executive comp; balance a bailout for institutions with aid to struggling mortgage holders? How does it value those mortgages? Is there adequate oversight? In fact, many of these smack of traditional Republican and Democratic infighting. But there are also aspects of fiercer ideological divisions: Should we be doing this at all? Here, left and right converge, the left saying no fat-cat firms should be rescued, the right arguing that government should get out of the markets. Then there's the apocalyptic moralists, who thunder that we must pay for our sins of excess and speculation.

There is a case to be made that beneath the cries of malfeasance, neglect or delusion -- the usual finger-pointing -- we are suffering through a classic break in the political economy. The cliché of the moment is lack of trust and confidence, not only in the markets, which still struggle to fully grasp the scale of the problem, but in a political culture that, if public opinion polls are valid, is searching for its own bottom. This lack of trust is symbiotic and synergistic; it feeds on itself. That's clearly what has happened in markets linked by complex instruments of unknown size and surprising vectors. But there's a profoundly political context to this as well. Why should we trust a government that led us into Iraq or treats "reality" as a plaything? Why should we bail out Wall Street -- the term is now slapped broadly on anything financial -- which has brought us Bear Stearns, Fannie, Freddie, AIG and Lehman? Why should we trust regulators, including Treasury, the Securities and Exchange Commission, the Federal Reserve, that were either complicit in these problems or missed them entirely?

There is a larger perspective on this, and it takes us back to the fundamental reordering of U.S. markets that occurred after the last great financial apocalypse, the crash of '29 and the Great Depression. In the midst of that calamity, new institutions shaped by new priorities -- primarily transparency and disclosure -- were erected. The SEC was formed, staffed and given the mandate to protect investors. Exchanges were brought under regulatory purview, albeit through a system of self-regulation. Commercial and investment banks were separated under Glass-Steagall, and an insurance plan for bank depositors installed. In time, mutual funds were regulated.

That was over 70 years ago. It's been apparent for some time that the financial system has outpaced, particularly over the past three decades, regulation, which remains dominated by the same institutions from the '30s. On top of it, the spirit of regulation -- the notion that markets require a steady hand and a consistent rule book to function optimally -- has, at best, been undermined, at worst, overturned. That argument, in fact, was immeasurably aided by long bull market runs, punctuated by relatively minor breaks, after the '70s. At the same time, globalization advanced, with its manifold benefits masking inevitable deficiencies. Over time, markets grew deeper, broader, with greater differentiation, providing clear benefit (and controversy) to a greater number of players, from companies to consumers. The sheer power of these markets began to reshape the financial economy. Commercial bank consolidation led to the steady erosion of limits, many quietly enabled by regulators, and the eventual scrapping of Glass-Steagall: a powerful example of institutional convergence without a compensatory regulatory convergence. Questions of competitiveness and efficiency prevailed over safety and soundness. Liquidity edged out transparency; speculation subsumed investment. For years, the banking system seemed sounder, particularly after banks diversified, sold off loans and engaged in techniques like securitization.

But there were deeper dynamics at play. Finance was growing more complex. The rise of derivatives gets most of the blame, but it was more fundamental than that. Banks and firms grew bigger, more global, and they spawned organizational and managerial conflicts, contradictions and span-of-control issues. Liquidity fed the proliferation of unsupervised instruments. Spurred by powerful tools, by the freedom to experiment and by public equity markets demanding growth, product cycles whirled faster. This produced benefits: Many new instruments began as risk management tools, and the very speed of adoption suggested an efficient system that quickly arbitraged away profits. But it also created a fiercely speculative pressure cooker of big bets, high comp, ample liquidity. And it created stresses within major firms, which needed to combine great size with speed, risk and leverage, to survive.

Under those conditions, regulators hadn't a chance -- Analystgate, the backdating and accounting scandals were early signs -- and their woes were exacerbated by a belief in continually self-correcting markets. Deregulation can be blamed, but it was a halfway-house deregulation that left firms, markets and regulators themselves awash in ambiguity, entangled in rules but free to bet, innovate, shift capital, leverage up. There is a bigger problem here as well. If the system lost control because of complexity and innovation, the gap between finance and the "real" world widened too (even as finance increasingly penetrated so-called Main Street). Good times fed a broad psychological consensus, a bubble mentality. But as cracks appeared in the ramshackle structure of mortgage finance, the reality -- the ambiguities, opacities, feedback loops -- deepened. The political debate now occurs over that yawning chasm between the profound complexity of the situation and pundits, politicians, ordinary voters with, at best, limited knowledge. It's an invitation for the technocratic solution Treasury Secretary Henry Paulson put forth: Trust me, the experts will handle this. It's also an inducement to demagoguery.

Of course, we've been here before, and there's hope in that. But the real problems only begin with the Paulson plan. Over the next few years, a new administration and Congress will have to rebuild a regulatory system, putting them up against the architects of the New Deal. There are difficult, subtle, complex and fundamental issues to be considered and resolved. If the bailout plan is the first exam, there are still many more to go. The question is: Are we up to it?