ObamaMatt Taibbi’s response to President Obama’s defense of his financial reform record (and an attack on Taibbi’s reporting) should be read by anyone who wants to understand the big picture. Obama’s defense focuses on how Dodd-Frank is still evolving as the rules roll out, but then he says this:

I’ve looked at some of Rolling Stone’s articles that say, “This didn’t go far enough, we didn’t institute Glass-Steagall” and so forth, and I pushed my economic team very hard on some of those questions. But there is not evidence that having Glass-Steagall in place would somehow change the dynamic. Lehman Brothers wasn’t a commercial bank, it was an investment bank. AIG wasn’t an FDIC-insured bank, it was an insurance institution. So the problem in today’s financial sector can’t be solved simply by re-imposing models that were created in the 1930s.

He then goes on to talk about changing incentives in Wall Street executive compensation, which goes to changes in corporate governance and the ability for corporate boards to change compensation structures to those who take the risks are on the hook for the losses. And Obama, perhaps pre-throwing up his hands, says “that’s not something that can entirely be legislated.”

But back to his argument. Taibbi is pretty polite about it, but Obama’s defense involves a lot of misdirection. It assumes that Lehman Brothers, by virtue of having failed, was the only financial institution out there responsible for the collapse, rather than an example of industry-wide behavior.

As Taibbi writes, Lehman was allowed to fail for idiosyncratic reasons, mainly involving Henry Paulson hating Dick Fuld. It could have been Bear Stearns, or Citigroup, or Bank of America that failed. And the mega-banks ushered in by Glass-Steagall repeal played outsized roles in the crisis.

Not only did they originate a lot of the dodgy loans that helped to create the housing bubble, they provided the warehouse loans to non-bank lenders like Countrywide and Ameriquest which sustained the mortgage securitization machine. Glass-Steagall repeal didn’t play the only role – Supreme Court opinions lifted restrictions on some inter-state bank mergers that led to the creation of large financial institutions like Washington Mutual and Wachovia – but they played a role.

In fact, the main beneficiary of repeal was Citi, which ended up requiring the largest bailout of any financial institution. It’s not for nothing that the Obama Administration was stocked with acolytes of Robert Rubin, the former Citi CEO. Sheila Bair mused in her book whether the entire bailout was more of a disguised strategy to save Citi.

Taibbi adds:

Opponents of Glass-Steagall will argue that companies like Citigroup and Wachovia would have been in trouble with or without Glass-Steagall, that those firms weren’t sunk by their new financial-supermarket structures, but by dumb investments in things like mortgages that might have been made by the dumb executives who ran those companies anyway – i.e. those executives would have been just as dumb if they were merely running commercial banks in the 2000s, instead of running cross-species financial behemoths that also offered i-banking and insurance services.

That might be true. But this would be an interesting argument for anyone in the Obama administration to make, given that president Obama brought in many people from the leadership of Citigroup to shape his economic policy, from chief of staff Jack Lew to transition team chief Michael Froman to a host of people connected in some form or another to former Citi executive and Glass-Steagall architect Bob Rubin (even Geithner served under Rubin in the Clinton administration).

What’s more, Dodd-Frank included a modern version of Glass-Steagall repeal! Merkley-Levin, or the Volcker rule, was originally designed to separate a lot of investment and commercial bank activity, through the ban on proprietary trading at depository institutions. The problem is that the Volcker rule may not bear much resemblance to its original form, weakened through the legislative process and potentially gutted in the regulatory process, which has yet to be finalized.

In addition, responding to criticism of Dodd-Frank by saying that reinstating Glass-Steagall would have been inappropriate belies the real issue. A series of regulatory and legislative changes over decades led us to this point, with too big to fail banks and outsized risk.

Dodd-Frank simply did not address enough of those changes, and really fell down in the crucial area of limiting bank size and leverage, which the Obama Administration specifically rallied against in the negotiations, stopping Brown-Kaufman. In the simplest terms, it’s this bloated financial industry that not only leads to terrible risk, but stunts the growth of developed economies.

We still have a time bomb ticking on Wall Street, and focusing on one piece of the criticism for that ignores the continued risk.