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Basically Square went through a lot of changes that started at the end of the PS1 era and came to full fruition during the PS3 era.  These changes were

1.  Square merged with Enix.  Square lost a ton of money making "Final Fantasy: Spirits Within", so they had to merge in order to survive. 
2.  Several key members left during this time period including Sakaguchi (FF creator and main writer), Uematsu (main composer).
3.  Going to HD slowed down game development for everyone, but it seemed to have hit Japanese companies even harder than Western ones.

Square has never been the same since.