The best explanation of the stock market’s recent swoon can be found this week not with Fed Chairman Alan Greenspan’s observations but in the hearing room of the Senate’s Permanent Subcommittee on Investigations, which showed greedy and often illegal behavior stopped at neither the companies benefiting directly nor with their accountants. The subcommittee’s exposure of the banking industry as apparent conspirators in Enron’s phony balance sheets opens a broad new area of inquiry.

In brief, hearings this week of the subcommittee, of which Sen. Susan Collins is the ranking Republican member, showed that J.P. Morgan/Chase and Citigroup helped hide Enron debt, making the company look healthier to investors. The banks hid the debt by creating paperwork to make it appear companies were buying energy at a future date from Enron. In fact, the companies were made up and the financial institutions were merely providing loans to Enron – loans the energy company did not want on its books. The financial institutions benefited by gaining an enormous amount of business; members of the public lost through deception.

The first conclusion investors would draw from these revelations is that if these banks were behaving this way, so were others. (The second conclusion might be that Enron, Arthur Andersen and the banks are much better at keeping secrets than anyone in, say, government – an idea the Homeland Security people might keep in mind as they search for recruits.) The investors’ reaction to dump potential losers at small losses now rather than absorb large losses later is both sensible and predictable. The financial institutions will have to work hard to sort themselves out so that investors will regain confidence in their performances.

This will take some time. Internal memos from the banks reveal blatant and willful cheating. For instance, a 1998 e-mail from a Chase banker said, “Enron loves these deals as they are able to hide funded debt from their equity analysts because they (at the very least) book it as deferred rev[enue] or (better yet) bury it in their trading liabilities.” Not to be outdone, a Citigroup employee in 2000 helpfully explained to colleagues how to describe this bookkeeping system to potential investors: “Get into why co[mpany] does it (gets cash flow, shows up as other liab[ilities] not debt …) … i.e., [g]ives some oomph to revenues … [Enron] gets money that gives them c[ash]flow but does not show up on books as big D Debt.”

From “big D” to the Big House may not be that far a step. Sen. Collins commented Tuesday that “restoring faith in America’s capital markets requires that all the players do their jobs – not just government regulators and prosecutors but lawyers, accountants, investment bankers, market analysts, corporate management and boards – in accordance with the spirit, not merely the letter, of the law.” That includes thorough and aggressive investigations by the Justice Department. The subcommittee’s work provides an excellent basis for bringing criminal charges.

Fully exposing the breadth of this scandal, as the subcommittee is attempting to do, is just the beginning. Confidence will be restored when some of the banking and financial regulations dismantled in the 1990s are replaced and those who abused the system are brought to trial.