Leading article: This financial crisis should never have been allowed to happen

Even by recent standards, it has been a stormy week in the global financial markets. The Federal Reserve cut interest rates by 50 basis points to avert recession in the US and world economies. Meanwhile, the price of gold rose to its highest level in nearly 28 years, a sign that investors are seeking shelter from the recent market uncertainty. Events have been even more extreme here in Britain. We saw the first run on a bank in more than a century, as ordinary depositors queued to get their money out of branches of Northern Rock. To stem the panic, the Treasury was forced into the effective nationalisation of the bank, an action with dangerous implications. Finally, the Bank of England governor, Mervyn King, underwent an extremely hostile questioning in front of a House of Commons committee.

Although he seems to have done enough to save his job, Mr King's testimony before the Treasury Select Committee on Thursday was hardly a triumph. His firm initial refusal to inject money into the system looks entirely inconsistent with the Bank's behaviour in recent days. But Mr King is not the only one culpable. The banking sector's regulator, the Financial Services Authority, should have been more alive to the threat to Northern Rock and acted sooner to put a possible rescue package in place. What occurred in the past week was a failure of crisis management. The granting of independence to the Bank of England has been a success in depoliticising interest rate decisions. But the "tripartite system" of Treasury, FSA and Bank of England supervision of the markets has shown itself to be worryingly flat-footed in a crisis.

But it is important that we do not lose sight of the bigger picture amid the recriminations about the handling of this affair. The immediate cause of Northern Rock's difficulties was that other banks began refusing to lend to it. It is true that the bank in question had left itself exposed because of its unwise business model of being almost wholly reliant on access to wholesale money markets. Yet the drying-up of liquidity in the banking sector, not Northern Rock's collapse, was the trigger for the crisis. And the reasons for the banking credit squeeze is a lack of transparency over which financial institutions are holding the billions in dodgy loans exposed by the collapse of the US sub-prime mortgage market in the summer. Banks do not want to lend to each other because they cannot be confident of getting their money back.

So how did we get to this wretched situation? The commercial banks are largely to blame. They lent unwisely and bought up complicated credit securities without fully understanding them. They allowed their greed for higher returns to cloud their judgements. Credit agencies which gave high ratings to securities that are likely to prove worthless must also take some responsibility. Global monetary authorities must examine their behaviour, too. They kept interest rates too low in the wake of the global stock market collapse of 2001, stoking bubbles in the housing and credit markets.

The final piece in the jigsaw is regulation, or rather a failure of regulation to keep pace with the markets. The financial regulators in the US and Europe should have been more wary of the potentially destabilising consequences of allowing opaque credit instruments to be traded by the banks. And they should have been more alive to the interconnectedness of global banking.

No system of regulation is ever going to be perfect, but the FSA and the Bank of England could – and should – have done more to remove the punch bowl when the party got out of hand. The financial regulators and central banks have handled the crisis badly. But their greater failure was to allow it to develop in the first place.