The Obama administration's proposal for reforming financial regulation has many useful features. In particular, the proposed consumer financial protection agency likely would have prevented many of the worst abuses in the subprime market over the last decade, as well as in other areas of consumer lending.

Other measures, like requiring that standardised derivatives be traded as clearing houses and that hedge funds register their interests with the Securities and Exchange Commission are positive steps towards modernising regulation, although they do not go far enough.

The US Treasury should be trying to standardise all derivatives and have them exchange traded to maximise transparency. There also should be increased public disclosure of hedge fund dealings. But, these are not the biggest flaw in the administration's regulatory proposals. The biggest flaw is that they help to support the view that the main problem was inadequate regulations, rather than failed regulators.

The basic story of this crisis was not that the regulatory authorities lacked the ability to rein in this disaster before it was too late. Rather, the regulators – most importantly the Fed – opted not to use their power to rein in the housing bubble.

The Fed had ample tools at its disposal to burst the housing bubble before it expanded to such a dangerous size. To start, the Fed could have tried just providing information. First, Alan Greenspan could have devoted his congressional testimonies and other public appearances to warning about the housing bubble.

These warnings would include both a careful description of the evidence for the bubble (with tables and charts) and a detailed account of the damage that would be caused to both the economy and the financial sector from its collapse. The Fed could have also committed its staff of thousands of economists to detailing the case for a housing bubble and drawing out the implications for various regions and sectors of its collapse.

If Greenspan had followed this route, rather than insisting that there was no bubble, it is likely that it would have been sufficient by itself to burst the bubble. No major financial institution can simply ignore the Fed, and there was no plausible response to the argument showing the existence of a housing bubble.

If talk proved insufficient, the Fed should have used its regulatory authority to clamp down on many of the bad loans that were feeding the bubble. It eventually did issue guidelines that would have precluded many of these loans, but not until the middle of 2008.

Finally, if necessary, the Fed should have raised interest rates until the bubble burst. This would have been undesirable, since it would slow growth and raise unemployment, but it still would have been better than letting the bubble grow and create the basis for even more pain later. And the story of the crisis is the story of a collapsed housing bubble.

The discussion of financial issues has largely worked to hide the centrality of the housing bubble to the crisis. If there had been no credit default swaps, collateralised debt obligations or subprime and Alt-A mortgages but the housing bubble had still grown to $8tn, we would be in pretty much the same economic situation that we are in today.

Residential construction would have collapsed due to a huge glut in the housing market, and consumption would have plunged as a result of the loss of $8tn in household wealth. The financial problems created by failed regulation do complicate the picture, but the fundamental picture is a very simple one of a collapsed bubble causing demand to plummet.

Politicians and regulators have a direct interest in portraying the crisis as being the result of an inadequate regulatory apparatus rather than failed regulators, because failed regulators should get fired. However, by not holding failed regulators accountable, this reform proposal is setting the grounds for the next crisis.

Even a perfect regulatory structure will not work if the regulators do not do their job. They will not have an incentive to do their job if there are no consequences for failure.

In this case, we have seen the most disastrous possible regulatory failure. This is like a drunken school bus driver who gets all his passengers killed driving into oncoming traffic, and no one is held accountable. The message to future regulators is, therefore, to simply go along with the powers that be (ie the financial industry), and you will never suffer any negative consequences.