The government failed to monitor problems at British Energy, which runs the UK's nuclear power stations, the National Audit Office (NAO) has said.
British Energy underwent financial restructuring in October
Poor regulation by the Department of Trade & Industry (DTI) meant taxpayers had to pay £410m to meet the company's debts, the NAO said.
The watchdog said the DTI did not monitor how changes to the electricity market would affect costs and profits.
Late last year the company reached a life-saving debt restructuring deal.
NAO chief John Bourn said that the DTI "did not evaluate" how the effects of increased competition would increase British Energy's costs and reduce its income, as other, more flexible generators gained market share.
And the government adopted a "wait and see" approach despite growing evidence of the company's financial distress and awareness that is was "highly vulnerable" to a fall in the electricity price.
Jeremy Coleman, NAO assistant auditor general, told BBC Radio 4: "What our report shows is the DTI did really very little, and quite consciously did very little, to monitor British Energy's position until British Energy was visibly in serious trouble."
The DTI decided not to intervene unless the company was in "publicly evident distress", although it prepared contingency plans to ensure the security of supply.
In September 2002, the privatised company declared that it could not meet its liabilities, especially for the decommissioning of old reactors.
Despite the government rescue, its share price has collapsed and it is still struggling to remain economically viable.
But Brian Wilson, energy minister at the time the government bailed out British Energy said the blame could not solely fall on the DTI.
Mr Wilson said industry regulator Ofgem was also to blame.
He told Radio 4 that Ofgem's "sole objective" of reducing the cost of generated electricity was a driving force behind the problem, as it would always present dangers for nuclear generators because the industry is heavily regulated.
Mr Wilson added: "I think the wider lesson of this is to what extent can government abdicate that kind of fundamental policy to a regulator?"
The government's actions have also been sharply criticised by Edward Leigh, the Conservative chairman of the House of Commons Public Accounts Committee.
"We told the DTI to keep careful watch over British Energy. Instead, for several years, the DTI seems to have assumed the ostrich position, with head firmly buried in the sand," he said.
For the Liberal Democrats, Shadow Trade and Industry Secretary Malcolm Bruce MP said: "This report shows that British Energy continued to pay dividends that the company's performance could not justify.
"At the same time the DTI failed to realise the effect the new market for electricity would have on British Energy's profitability and the exposure of taxpayers to the company's nuclear liabilities."
Next week the Committee will take evidence from British Energy chairman Adrian Montague and Sir Robin Young, DTI permanent secretary.
The government declined to comment ahead of their testimony.
British Energy generates 20% of the UK's electricity.
Its biggest plant is at Hartlepool, with others at Sizewell, Suffolk; Hinkley Point, Somerset; Hunterston, Ayrshire; Dungeness, Kent; and Torness, East Lothian.
As part of its rescue package, the government will help meet some of the firm's future liabilities, such as the cost of decommissioning nuclear power plants.