THE INVESTMENT BANKING industry as we knew it is no more. Change has been inevitable ever since the Bush administration and the Federal Reserve Board decided to use taxpayer money to back J.P. Morgan Chase's takeover of Bear Stearns. R.I.P. the deregulatory trend that has dominated policy towards America's financial institutions. Enter the lawyers, regulators, and politicians to reshape the nation's financial markets.

Investment bankers might moan, but when they created a system rife with conflicts of interest and too few incentives to good performance, followed by acceptance of billions of taxpayer money, they sold their deregulated birthright. When Fed chairman Ben Bernanke received permission from the White House and Treasury Secretary Hank Paulson to take almost $30 billion of Bear Stearns' paper onto the Federal Reserve Banks' balance sheet--and to open the discount window to other investment banks, to use the jargon of the trade--it put the taxpayer at risk. If the IOUs on Bear's books prove worthless, the taxpayer will have to bear the loss--J.P. Morgan has agreed to shoulder only $1 billion of the $30 billion of risk now transferred to the Fed's books.

The move might have been necessary to induce J.P. Morgan Chase to take over Bear Stearns, an acquisition that in turn might have been necessary to avoid the collapse of the financial system--we will never really know. Perhaps the upcoming congressional hearings will determine why the Fed opened the discount window to investment banks only after it had arranged the takeover of Bear. In any event, the deed is done, and government is now the implicit guarantor of every major investment bank, no matter how much Paulson contends that the Bear takeover need not necessarily become the template for future policy.

Investment banks have never been as closely regulated as depository institutions, the commercial and savings banks. The depository institutions are insured by the government, which therefore feels obliged to ensure that they operate prudently and have adequate capital. Investment banks have until now not been subjected to what Paulson calls the "strong prudential oversight" to which commercial banks must submit. That suited Wall Street's macho free-marketeers, who wanted as little to do with Washington's regulators as possible.

Bear changed all of that. The government decided that it could not allow an investment bank to fail and, to the relief of a panicked Wall Street, committed billions of taxpayer funds to Bear's rescue and agreed to come to the aid of other investment banks that might in the future rattle their begging bowls at the Fed's discount window.

Paulson, the former chief of Goldman Sachs, unveiled the Treasury's 200-page blueprint for future regulation over the weekend. He would combine some of the regulatory functions now spread among several agencies, and increase the supervisory reach of the Fed. But he hopes that any serious new regulations will be temporary, and that future rules will be light-handed, a position somewhat at variance with his concession that access to taxpayer funds "should involve the same type of regulation and supervision" as applies to commercial banks. Investment banks, assured of a government life-line in the event of trouble, will lend recklessly, unless regulation constrains them--moral hazard on a grand scale.