The Financial Stability Report published this morning showcases the Bank of England’s capacity for analysis. It succinctly assesses the causes of what it calls “the most severe challenge to the UK financial system for several decades”, tracing the credit crisis from the ex-urbs of America to the banks of the Tyne.

Homeowners in the ex-urbs and cheaper suburbs of America started to struggle to pay their mortgages; investors that had bought bundles of debt, including US sub-prime mortgages, saw these so-called asset-backed securities suddenly plummet in value; financiers everywhere were caught by surprise and, fearful of unforeseen problems elsewhere in the credit markets, simply stopped lending; then, banks that roll over debts month by month to fund a range of businesses started hoarding cash; at which point institutions like Northern Rock, which depended on other banks rather than their own depositors to fund their business, ran into trouble.

As important as the history lesson was the futurology. The Bank warns that the UK is vulnerable to further shocks. There are potential problems, it says, in the UK commercial property market. Prices are not rising as fast as they were. A large backlog of projects raises the danger of a glut of office space. And lenders to property developers have started issuing tougher terms.

It suggests there may be trouble ahead both for businesses and households that rely on borrowing: the Bank offers a timely reminder of how the financial sector’s losses in the early 1990s took their toll of corporate profits. As lending becomes more expensive and more scarce, indebted corporates are bound to suffer. And the Report serves as a sell note on the US equity market and the dollar.

The Bank has laid out clearly the lessons of the past few months. Banks need to improve their liquidity management, investors need greater scrutiny of clever structured financial products and consumers need to have confidence that the money they put in the bank is backed by a meaningful insurance scheme.

But for all its evident powers of diagnosis, the Bank’s own assessment of the problems in the financial markets falls short when it considers its own part in remedying the situation. It glances at the question of how the Bank, the Treasury and the Financial Services Authority work together. It suggests that greater stress testing is necessary in the regulation of banks, albeit a little after the fact. And the Financial Stablity Report does not address the key debate over whether Mervyn King, the Bank Governor, was right in August to take the high ground on the issue of moral hazard and refuse to extend three-month money to the likes of Northern Rock.

Economist, heal thyself.

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