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The recent collapse of several investment banks on Wall Street is one of those stories that is hard to understand and easy to dismiss. Besides, you might say, my money is safe in the bank down the street.

But the financial meltdown tells us plenty about how a McCain or an Obama administration would handle the country’s economy, and whether we will bring stability back to the financial market, or keep blindly repeating the boom-bust cycle.

The story of today’s meltdown has its roots in forgetting the lessons of the Great Depression. In the aftermath of that era’s banking crash, Congress passed the Glass-Steagall Act of 1933. It was designed to protect people’s deposits in two ways.

First, it established the Federal Deposit Insurance Corporation (FDIC), which now protects deposits of up to $100,000 in case the bank defaults. The FDIC restored faith in the U.S. banking system, and is the reason why most people put their money in the bank, and not in their mattress.

The other major thing the Glass-Steagall Act did is separate traditional deposit banks from private investment banks.

The main reason for the separation is that private investment banks trade in much riskier investments such as stocks and debt obligations. If those deals go sour – as they did in the late 1920s and early 1930s – then the deposits of regular citizens are at risk, since their money can used to cover bad investments.

Fast-forward to 1999. Then-Sen. Phil Gramm (R-Texas) decreed the Glass-Steagall Act was holding back financial institutions from their real moneymaking potential.

So, in 1999, lubricated by a $300 million lobbying campaign by the financial industry, chairman of the U.S. Senate Banking Committee Gramm was able to pass the Gramm-Leach-Bliley Act (not one of the finer sponsorship moments for former Republican Rep. Jim Leach of Iowa).

The Act had the misleading official title of “The Financial Modernization Act of 1999.” In this case, the term “financial modernization” meant returning the financial industry to the 1920s, a time before all those darned regulations.

As Bill Clinton signed the Act into law (this was a bipartisan folly), Gramm beamed with his notion of progress.

“We are here today to repeal Glass-Steagall because we have learned that government is not the answer. We have learned that freedom and competition are the answers. We have learned that we promote economic growth and we promote stability by having competition and freedom,” Gramm said.

Since then, banks, securities companies, and insurance institutions have all competed in the same businesses, dishing out risky subprime loans, and then repackaging and reselling the mortgages as safe investments. Other schemes like “structured investment vehicles” gambled and lost billions of dollars in short term and long term investments in an attempt to profit on the differences in interest rates.

When people began experiencing the slide in real estate values earlier this year Phil Gramm, architect of the current Wall Street mess, said the economic distress is just in our heads, and our complaining is turning us into “a nation of whiners.”

Although “government is not the answer,” guess who gets to salvage the financial system?

Within the past few weeks, the U.S. government propped up investment house Bear Stearns so it could be sold and took over the defaulting Fannie Mae and Freddie Mac, the oddly-named private corporations that handle about 70 percent of the country’s mortgage business (“an extraordinary federal intervention in private enterprise” that could cost up to $200 billion, the New York Times says).

But the failures continue to grow, and as we spend $3.5 billion a week on two ongoing wars, further increasing record deficits, we can’t afford more government bailouts (and perhaps we shouldn’t bail out the industry that got deregulation they asked for). So the Federal Reserve Bank and Treasury and could only watch as Bank of America (which bought the failing Countrywide earlier this year) bought an ailing Merrill Lynch, and as Lehman Brothers—unable to find a buyer—declared bankruptcy. Yet, as I write this, the Federal Reserve Bank just rescued insurance giant A.I.G. with a $85 billion bailout, which gives the Fed 79.9 percent ownership of the company.

Here’s where the presidential candidates come into play.

The McCain-Palin ticket says they feel America’s pain, and mention “reform,” but their record indicates they long ago cast their lot with the trickle-down economics of Phil Gramm. In fact, Gramm was McCain’s campaign co-chair and chief economic advisor until July, when Gramm became a liability after calling the rest of us “whiners.” Still, Gramm remains an important unofficial advisor to McCain, which says a lot about McCain’s approach to the financial industry.

McCain’s running mate, Alaska Gov. Sarah Palin, repeated Gramm’s anti-government stance when she recently told ABC news that “Government has got to get out of the way” of the private sector so it can create jobs.

But, on the particulars of the financial scandal, Palin seemed to be confused, as she told ABC “We have got to make sure that we reform the oversight, also, of the agencies, including the quasi-government agencies, like Freddie and Fannie, those things that have created an atmosphere here in America where people are fearful of losing their homes.”

For the record, Freddie (Mac) and Fannie (Mae) were private sector institutions that were taken over by the government in order to help end the atmosphere in America where people are fearful of losing their homes.

On the Democratic ticket, Obama-Biden recommend an approach for re-regulating the financial markets. On the day Lehman Brothers declared bankruptcy, Barack Obama issued this statement:

“I certainly don’t fault Senator McCain for these problems, but I do fault the economic philosophy he subscribes to…It’s a philosophy that says even common-sense regulations are unnecessary and unwise, and one that says we should just stick our heads in the sand and ignore economic problems until they spiral into crises.”

Now we’ve come full circle in the financial crisis. There aren’t runs on consumer banks like in the 1930s, but in meeting rooms on Wall Street and over the phone lines, there is clearly panic. And as investment banks continue to fail, the rest of the financial system will continue to pull back credit, and the entire U.S. and global economy will continue to slow down.

Just like the citizens who had to be convinced to put their money back into banks after the crash in the Great Depression, investors from outside the U.S. – China, Japan, Korea, Saudi Arabia, and other countries help to keep us afloat – won’t be as eager to buy U.S. securities until updated regulations make the market more fair, safe and predictable.

Wall Street photo: http://www.flickr.com/photos/acampada/287387997

Phil Gramm photo: http://www.flickr.com/photos/tonythemisfit/2657608264

updated Sept. 17, 9:39 a.m. CT