Hamish McRae: Northern Rock has been appallingly badly handled - but good may yet come out of it

This is about trust. Trust in the regulators; trust in the banking system; trust in the government itself. The immediate banking crisis is over, as it should be, for if an unlimited Treasury guarantee of all deposits did not restore calm to the markets I don't know what would. But this has not been well handled – it has been appalling handled.

While the full consequences of that will only gradually become clear, it is, however, possible to make an initial assessment of the damage and to start to figure out where the risks lie ahead.

The damage to the regulators, the Bank of England and the Financial Services Authority, is obvious. To allow the biggest banking crisis to develop since the 1970s fringe bank collapses is an astounding failure. It suggests a puzzling lack of awareness of that most basic rule of banking regulation: you never allow a run on a bank to get going in the first place. The primary blame lies with Northern Rock management, which has displayed an unpleasant mixture of bombast and whinge. But the test of regulation is how it copes with bad managements and here the system has failed.

In an ideal world the weakness of Northern Rock would never have been allowed to come to light until a solution was found. It should have been taken over by a larger and strongly funded enterprise. It is not quite clear why the mooted takeover by Lloyds TSB failed – I have heard different stories – but once the queues began outside the branches last week, the danger of a systemic banking failure should have been clear.

The unprecedented nature of this run on Northern Rock was pretty clear to us in the press and a rescue over the weekend would have been the classic response. But the authorities didn't do it. They evidently did not understand the gravity of the situation until Monday afternoon, with the astonishing about-turn by the Chancellor.

It is too early to apportion blame between the Treasury, the Bank and the FSA – or indeed the structure whereby supervision was taken away from the Bank and the FSA was created, a decision of the present Prime Minister. But none of them come well out of this and the only explanation I can give is one of inappropriate experience.

Take the Bank. The governor, Mervyn King, is one of the best British economists of his generation but he is not a banker. The two deputy governors are both former treasury mandarins. They are all honourable, clever and actually very nice people. But none of them have any experience of handling a run on the banks. The Bank seems to have no collective folk memory of what it was like in the fringe bank crisis, when a rumour was enough to sweep away sound banks along with the rubbishy ones.

As for the FSA, its people behaved like corporate lawyers covering their tails instead of really understanding how to reinforce depositors' confidence. Take this small example. On Saturday evening the FSA put out a statement quoting Sir Callum McCarthy, its chairman:

"To be absolutely clear, if we believed that Northern Rock was not solvent, we would not have allowed it to remain open for business. It is open for business and it can continue to receive deposits and allow customers to make withdrawals."

Fair enough. But at the top of the email, the first thing you saw was this line: "Your attention is drawn to the warning notice at the end of this message." And what did that say? The usual legal guff including: "This email is not intended to nor should it be taken to create any legal relations or contractual relationships."

Now I accept that such emails have to have formal legal qualifications but why on earth, if you are trying to reassure people, do you start out by drawing particular attention to the fact that your assurance has no legal significance? Why deliberately undermine your message? Stupid.

And the Chancellor? Well funnily enough I think he may come out of it rather well. Sure he made a bit of a prat of himself on Monday, coming out in the morning by stressing the solvency of Northern Rock, and then switching to a complete and unqualified guarantee of deposits that evening. But I suspect he was badly advised and when push came to shove he did the right thing. Besides, he is new in the job and was not responsible for any of the run-up to all this.

The politician who may come out badly is Gordon Brown. There are two charges against him. One is specific, the other general. The first concerns the regulatory structure. You may remember that the then governor, Sir Eddie George, was so concerned that he considered resignation when supervision was taken away from the Bank. The fringe bank crisis was partly because supervision at that time was split between the Department of Trade and Industry and the Bank. As a result all supervision was consolidated under the Bank. So taking it away and creating the FSA may have been a bad decision.

The second concerns the general climate of excessive borrowing that the former Chancellor permitted and arguably provoked by his own unplanned budget deficits. If the UK economy were to go into a slowdown, partly as a result of these ructions, the new Chancellor would not be able to offset this by increasing the budget deficit. At nearly 3 per cent of GDP it is already at the top end of the acceptable range.

That leads to the risks ahead. I am not worried about lack of "moral hazard" in the banking system as a result of the bail-out. The management of Northern Rock has to be cleared out, as apparently Alistair Darling believes. Having your bank wiped out is pretty good punishment for any management, so others will be wiser in future. There will have to be a new deposit guarantee scheme, perhaps with an explicit limit of £100,000, and it will have to be made clear that the present blanket treasury support for deposits lapses once the crisis is over.

There will have been some damage to London's financial reputation and there will have to be reforms at both the Bank and the FSA. There is a problem and hence a risk to an enormously important industry. Trust in the competence of the regulators needs to be restored.

And the risk to the economy, the most important risk of all? Well at some stage the artificial boost to consumer demand from the housing boom had to come to an end. A squeeze on the availability of mortgage finance is no bad thing. Were there to be a plunge in house prices as a result of mortgage famine, then there would be serious damage to economic demand. But were the fall is modest, then the economy would probably grow in a more balanced and sustainable way. In any case interest rates no longer need to go up and may start to come down, as in the US.

I would not say that the run on Northern Rock is a blessing in disguise; that would be silly. But it may well turn out to mark the symbolic end to the borrowing binge – so there is a silver lining.