The Treasury was under-prepared and "caught flat-footed" by the run on Northern Rock almost two years ago, MPs have said.

Northern Rock was the first British bank to fall victim of the credit crunch and had to be bailed out by almost £27 billion in emergency loans from the Bank of England. It was nationalised in February 2008.

As of March 2009 it still owed around £9.8 billion to the taxpayer, but has since slowed repayments of the debt to lend an extra £14 billion over the next two years to help the housing market.

Responding to a damning report published by the National Audit Office (NAO) in March, the Public Accounts Committee (PAC) attacked the Treasury's lack of readiness to deal with a failing bank despite warning signs emerging as early as 2004.

PAC chairman Edward Leigh said: "The Treasury must never again be so ill-prepared. As this crisis has shown, the Treasury's ability to respond effectively to future financial crises must be maintained at the highest level."

The spending watchdog said the bank was offering its infamous Together mortgage - lending borrowers up to 125 per cent of the value of their homes - from the time of its emergency support until it was on the brink of public ownership.

The NAO also found the Treasury failed to properly assess risks, carry out its own due diligence, or challenge over-optimistic business plans after nationalising the lender.

Mr Leigh added: "The taxpayer was exposed to enormous risks and liabilities to an unknown degree."

In 2007, there were around 60 staff working on financial stability issues in the Treasury, but the pace at which it worked on measures to deal with a bank in difficulty was "leisurely", the PAC's report said.

The Treasury's financial stability staff in this area has since doubled to 120 and the department has plans to increase it to more than 160 by the end of the year.

Northern Rock's business plan was based on a 5 per cent fall in house prices in 2008, with its "recession" scenario factoring in a 20 per cent fall over three years. But house prices fell by 15.9 per cent during 2008, the biggest annual drop on record, according to building society Nationwide.

MPs said the Treasury had been right not to pay investment bank Goldman Sachs a £4 million "success fee" for its work on Northern Rock when success had not been defined - but criticised it for signing a contract which did not allow it access to the financial models used by Goldman.

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