Regulation could have forbade these instruments, or penalized banks that held them, but that would run a serious risk of stifling innovation, which we don't want to do. Bankers should be smart enough to reject innovations that are not transparent enough to be really useful. The real regulatory failure that is clear now (in retrospect) is that capital requirements for investment banks and hedge funds (and insurance companies that acted like hedge funds) were too low. This is the area that needs attention as we review regulation in the light of the crisis. The commercial banks and thrifts, with their higher capital requirements, are mostly OK.
While we're on the subject, I was always a fan of the original rescue plan for the Treasury to buy distressed mortgage-backed securities from the banks in a reverse auction. The government would not have had to buy all of them in order to establish a price, and private demand would have followed. Once a price was set, the size of the banks' losses is determined, and on that basis they could have gone to the private market to raise capital. But the approach that was followed (direct injections of equity capital from the Treasury) did not resolve the uncertainty about the magnitude of the banks' losses, and so did not open the private market to them. Who wants to inject capital into a bank and then see it eaten up by toxic securities that were already on the books?