The report says the FSA failed to check Northern Rock's business plan
The Financial Services Authority is guilty of a "systematic failure of duty" over the Northern Rock crisis, a key parliamentary committee has said.
The Treasury committee said the UK's financial watchdog should have spotted the bank's "reckless" business plan.
To help prevent any further crisis, the report calls for the Bank of England to set up a head of financial stability.
The FSA said it had already admitted failings in relation to Northern Rock and was "addressing" them.
"We will also examine carefully any further lessons that emerge from our internal review of the supervision of Northern Rock," it said in a statement.
Committee chairman John McFall said Northern Rock's directors were primarily to blame, but added that financial stability safeguards "failed abysmally".
"Northern Rock had only one well from which to drink, and the FSA should have realised that," he said.
"It was a failure of the regulator not to see systemic risk."
Northern Rock has been given £25bn of emergency Bank of England loans.
The funds - which are, in effect, taxpayers' money - have been given to Northern Rock since last September.
The Newcastle-based lender got itself into financial difficulties because its business model left it ill-prepared for the global credit crunch.
Unlike the great majority of UK banks, Northern Rock relied upon borrowing funds from the wholesale money markets to fund its mortgage business, rather than the usual method of using savers' deposits.
Yet when the credit crunch hit, Northern Rock suddenly found it could not secure the cheap funds it needed, as credit was either unavailable or markedly more expensive.
As the first emergency loan from the Bank of England was announced, thousands of Northern Rock savers rushed to withdraw their funds, before the government's pledge to guarantee all savings.
The tripartite Treasury Committee report said the Financial Services Authority (FSA) had failed to "stress-test" Northern Rock's business model sufficiently.
The report also said the UK's tripartite financial authorities - the FSA, the Treasury and the Bank of England - were insufficiently prepared to deal with Northern Rock's difficulties and needed to communicate better with each other.
It wants to see the creation of a head of financial security at the Bank of England, who will act as a key adviser to the chancellor.
REPORT CALLS FOR
New head of financial stability at the Bank of England
Industry fund to protect deposits at failing bank
Special regime to take over running of any crisis-hit bank
The report also calls for the establishment of a deposit protection fund, funded by the UK's commercial banks.
The report wants the establishment of a "special resolution regime" for failing banks, to restore their health or "ensure an orderly failure".
The FSA said it would be publishing the conclusions of its own review in March.
HAVE YOUR SAY
Shadow chief secretary to the Treasury Philip Hammond said the MPs' report was a "crushing indictment" of both Northern Rock's management and the government.
If Northern Rock had failed, thousands would have lost their money and the country would have gone into shock
"It's probably one of the most damning reports that any select committee has put out in recent times," he added.
Liberal Democrat Treasury spokesman Vince Cable said Northern Rock's managers "behaved like a bunch of cowboys".
"And the FSA did nothing to rein them in, or even appear to see there was a problem."
The government is continuing efforts to find a private buyer for Northern Rock.
It has proposed turning the £25bn of loans from the Bank of England into government bonds, which will then be sold on to investors.