If investment banks and holding companies remained separate the CDSs never would've become so pervasive.

But you have to ask why bankers piled up a mountain of risk that in hindsight could not possibly have a happy ending. Obviously investment-grade US mortgages had a very low default rate, but you'd have to ask whether and why the bankers who converted shonky mortgages to investment grade using the instruments you describe, believed it could be true. Either they didn't believe, in which case it's hard not to describe the behavior as fraud, or they did believe because they thought they had evidence from tools like Li's Gaussian copula formulae. In that case they were merely incompetent.

To blame government for this faulty behavior seems like blaming government for drunk driving because they relaxed Prohibition.