As the Greek drama continues, a chorus in the EU is singing ditties about the need to end “speculation” in credit default swaps (CDS). However, the real problem in sovereign CDS – as in many other instruments – isn’t trading in CDS, even when this is imbued with speculative exuberance. The real market hazard isn’t speculation – it’s structuring, that is, designing financial products to hide risk, not price it. This means using derivatives – usually not CDS, by the way – to transfer obligations so no one knows they’re there, playing games at the end of a quarter to make books look better or helping to hide taxable income. None of this is the same as issuing an instrument like a CDS reflecting real risk – like whether Greece will in fact default now that the scope of its deficit is finally laid bare.

Regulators are now having a tough time telling risk from wrong. One reason for this rush to treat lots of reasonable activities as wrong ones is that regulators often spotted the problems coming, but then failed to back initial statements with meaningful action. Thus, they now unsurprisingly blame others for the market’s mess instead of considering how it could have been averted by a bit of prudent implementation of promulgated statements.

As the structuring case makes clear, it isn’t that regulators were clueless as the cataclysm came upon them. In 2007, U.S. regulators finally issued inter-agency guidance designed to block commercial and investment banks from structuring financial instruments to obscure economic reality. The call for action in this area came after Enron, which was of course a poster-child client for complex, structured and misleading financial instruments. The regulators started with tough anti-structuring guidance in 2004, revised it in 2006 and then finally issued standards in January of 2007. The final standards were a lot less stringent than the initial ones, but still would have blocked actions like those alleged for Goldman Sachs in Greece had anyone cared to comply with or enforce them.

In fact, the structuring guidance was not only ignored, but actively flaunted. An array of complex financial instruments – some of them rightly called “structured” at the start – went from the trickle at the start of the rulemaking process to a torrent after its close.

But, the structuring guidance isn’t the only one regulators put on the books as they fretted over market developments. Another example is 2005 guidance on home-equity loans. It rightly noted the risks in second liens and told banks in clear, uncompromising terms to limit it. Of course, piggyback mortgages continued their uninterrupted, exponential growth. They are now a major source not only of borrower distress in foreclosure-prevention deliberations, but also a looming risk to the large banks that hold so much of this paper.

In 2006, the agencies put out long-delayed guidance on “non-traditional” mortgages – that is, the mortgages with option-ARM or other features that are now littered across the foreclosure landscape. Again, the guidance came late and looked tough, but led to nothing of note at either the financial industry or its regulators.

It isn’t, of course, that all structured deals are wrong – even Citi’s “structured investment vehicles” would have been fine had they been backed by appropriate capital and funding. It’s just that some structures – those designed to deceive, evade or confuse – aren’t so fine and should have been shut down when they first came to supervisory notice.

Similarly, it isn’t that second liens are bad – home-equity loans are a longstanding and appropriate feature of residential finance. But, when they are booked to evade GSE requirements or cover up true loan-to-value ratios to misrepresent MBS risk, then they’re not. Again, when regulators were on to the gig, they should have shut it down.

That they didn’t is posing significant costs not just to the regulators’ pride, but also to the financial-services industry. Had structured instruments been blocked from the start, industry critics now would have a far more difficult time shutting down CDS trading because the issue would be nowhere near as confused as it’s become. Telling the difference between “good” CDS activities and “bad” ones is too hard for aggrieved politicians in the midst of crisis – hence the calls in the EU for a flat-out shut-down. Similarly, some of the mortgage-risk control proposals now in vogue are far more draconian than need be, but policy-makers are understandably tempted by them because they have difficulty differentiating legitimate risk from high-flying hype.

The more confused policy-makers become – and they’re plenty confused right now – the stronger the push simply to block risk. Of course, financial institutions are in the risk-intermediation business and, if there isn’t any risk, there isn’t any financial industry. So, working to right the regulatory balance is not just an exercise in casting aspersions on past mistakes – that would keep us all way too busy. Rather, it needs now to be a set of carefully-calibrated, disciplined strategic judgments that start with the industry and are then vetted by regulators to bring market practice back in balance not only with policy, but also with legitimate profit, objectives.