Mervyn King made a big mistake last week. But it was not in his handling of the rescue of Northern Rock, which will probably be seen with hindsight as one of the more successful crisis management exercises in the chequered history of modern central banking. As Mr King noted in last week’s Treasury Committee interrogation, no depositor has lost money and a potentially catastrophic threat to the British banking system has been averted. Moreover, Mr King could have added, the crisis has been resolved at what will almost certainly be zero cost to the public purse.

Most importantly, it now looks like the British economy will not be damaged at all by the Northern Rock crisis. The global credit crunch will certainly slow the growth of global financial businesses and probably housing markets that are highly dependent on the City of London, but that has nothing to do with the specific problems of Northern Rock.

What, then, was the crime for which Mr King deserved to be pilloried on newspaper front pages and magazine covers? He was jeered by the media and the City for performing a “humiliating U-turn” because of a technical change in the terms of the money market assistance he started offering after dealing with Northern Rock. But viewed objectively, his actions were nothing more than what he described to the Treasury Committee on Thursday: a minor technical adjustment to reflect changing conditions in the money markets.

During his 16 years as a central banker, Mr King has won deserved plaudits from around the world for his pragmatism and his willingness to change his mind in making policy judgments. This same adaptability to changing financial conditions, far from exposing him to ridicule, should have confirmed his status as one of the most pragmatic and successful central bankers in the world.

Why, then, was the Governor so badly battered by his Treasury Committee interrogation, to the point where questions about his future are seriously being asked? Because he came across as the leader of an institution that seemed to have neglected some of its key responsibilities, not only this summer, but ever since it was split into two by Gordon Brown.

Mr King’s first mistake was a matter of presentational tactics. In his first public statement after the crisis, he should have focused on the one key issue that he had earlier identified as the heart of this crisis – the inadequacy of Britain’s deposit insurance system, which virtually guaranteed a bank run the moment lender of last resort (LOLR) assistance to any institution was rumoured or announced. He decided instead to offer a much more complex and nuanced analysis, blaming the crisis on four interacting problems: the antiquated deposit insurance system; the City Takeover Code, which now makes it impossible to force overnight mergers between banks; British insolvency law, which gives bank depositors the lowest ranking among creditors in a financial collapse; and finally – and most dangerously from the Bank’s standpoint– the European Market Abuse Directive, which apparently forbids the Bank offering covert LOLR assistance to financial institutions, as it would have done in the past.

This long list of obstacles had the obvious presentational drawbacks. It distracted attention from the main issues, it encouraged all sorts of other questions – for example about the technical details of the Bank’s money market operations – and it created the impression that the Bank was flailing around for excuses and alibis.

Far worse, the Bank’s poorly planned presentation suggested a deeper management failure, epitomised by the confusion of responsibilities in the tripartite regulatory structure which Mr King and his colleagues kept defending to so little avail.

This managerial failure was highlighted inadvertently by Mr King’s decision to focus on the Market Abuse Directive (aptly abbreviated to MAD). While he never explicitly linked the MAD to the EU directive of the same name, his implication seemed clear: “Here is another piece of cockeyed European legislation imposed by Brussels against the better judgment of British institutions such as the Bank.”

What Mr King did not mention – perhaps because he was himself unaware of it – was that the MAD that had stymied his efforts was not the one imposed by the Eurocrats in Brussels. It was a home-grown version, which in the manner typical of the British Civil Service, had hardened and extended the European proposal, making it more oppressive and less workable than the rules Brussels proposed. Moreover, the civil servants responsible for this “gold-plating” were none other than the Bank’s partners in the tripartite structure which Mr King kept defending – the Treasury and the FSA. The bizarre and self-defeating regulations spotted last week by the Bank’s lawyers were invented by officials working for Gordon Brown in 2004-05, just when their boss was promising to end such unnecessary “gold-plating” of EU directives.

To cap it all, the British MAD was written after long consultations in which interested parties were supposed to raise problems of exactly the kind now identified by the lawyers, but there were no objections from the Bank of England at the time. It seems that the Bank really was caught napping and had forgotten its crisis-management role – not just for the past two weeks, but since 2004 or before.

The MAD debacle suggests that the communications failures over Northern Rock have been a permanent feature of the Bank-Treasury-FSA tripartite relationship for years. It also suggests that the Bank, since its break-up in 1997, has lost touch with legal and financial complexities and thus undermined its main crisis management skills.

Bank officials kept repeating on Thursday that they could still have a “strategic overview” of market risks, even though they had no direct contact with individual banks and other institutions. This is manifestly absurd. The present division of responsibilities between the FSA, the Treasury and the Bank was tested last week – and unlike the other features of Britain’s economic arrangements, which passed with flying colours this one failed the test.

Mervyn King’s big mistake last week was to try to defend a tripartite regulatory system which he helped to devise in 1997 but which cannot now survive in its present form. The failure of this regulatory system, however, emphatically does not imply the failure of the Bank of England or its Governor. In its main role, the management of Britain’s monetary policy, the Bank has been a spectacular success.

Indeed, it has been the greatest institutional success seen in Britain since the Second World War. To question the Governor’s personal position is therefore to question all the economic achievements of the past decade.

If Gordon Brown wants to restore confidence in the financial system, and also in his own reforms of Britain’s economic management, after Northern Rock, his course of action should be clear. He should immediately announce a critical review of the tripartite regulatory system – and offer Mr King a new four-year term as Governor at the same time.

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