The New York Times headlines might have been written this week. "Terrible and Disastrous Financial Panic in London... Lombard Street Blockaded by a Tumultuous and Terror Stricken Mob... The Panic without Parallel in the Financial History of England..."

In fact they date from May 1866, and record the stunning collapse of the respected City banking house of Overend & Gurney – the "greatest instrument of credit in the Kingdom", according to The Times of London. Heirs to two centuries of Quaker banking probity, a new generation of partners had brought a highly profitable business to its knees.

Nicknamed "The Corner House", it was where bankers across the country placed their surplus funds, which, by the alchemy of 19th-century style banking were transmuted into working capital for Britain's merchants and manufacturers.

Seduced by the exuberance of the Victorian Golden Age, Overends plunged into the supposedly surefire "finance business" using their short-term deposits to finance long-term assets – ships, shipyards, and railroads were the flavour of the time.

When, as they inevitably do, conditions tightened, rumours spread, and the depositors started clamouring for their money back, the assets proved unsaleable and largely worthless – all in all, a Dickensian version of sub-prime debt. In the crisp words of Walter Bagehot, then Editor of The Economist, the partners ran their business "in a manner so reckless and foolish that one would think a child who had lent money in the City of London would have lent it better".

Money messes always start the same way. Judgment is fuddled by greed, ambition and overweening self confidence. When problems arise, there is an obstinate refusal to admit mistakes or the imminence of disaster; straws are clutched in the Micawberish delusion that something will turn up to save the day.

In Overends case, the partners believed the "something" would be a bailout by the Bank of England. A delegation of three sage bankers walked briskly from the Bank's imposing building in Threadneedle Street across to Overends dowdy offices, where a brief look at the ledgers told them all they need to know; Overends was broke. The Bank faced a delicate decision. If Overends failed, there would be panic. If they were saved, the many other firms in the "finance" game would also expect to be rescued.

In the end, the decision was that Overends were beyond salvation. There would be public alarm, but this would be short-lived. The essential thing was to prime the pump by increasing the amount of money in circulation, to which William Gladstone, Chancellor of The Exchequer readily agreed, provided Bank Rate was hiked to a penal ten percent.

Panic there was – the police had to be called to clear the clamouring crowds from Lombard Street. Some banks and many business who had been kept afloat by the "finance" business, failed too, but in a matter of months calm returned to the City's narrow streets.

Overend's depositors eventually got their money back, though even in those days, not without some complex litigation.

The partners lost their estates, their paintings and their money. Luckless public shareholders who had been induced to stump up cash in a foolish and fraudulent last-ditch attempt to stave off disaster, lost heavily too – as a result of which the partners faced a protracted criminal trial. Given the laws of the day, it ended in acquittal.

Life and the financial markets have moved forward light years since Overends collapsed. But some things do not change.

Crises and collapses recur with an almost Biblical regularity. Some claim that the seeds of the next problem are sown when the last executive who survived the previous one retires, and new "Masters of the Universe" swagger on to the scene.

Each one has its special features and each one calls for a different public sector response. But each one has the same roots: too much money looking for a higher return; too much greed; too many people who believe they really have invented a "sure thing".

Whether it be the London property market of the 1970s, the "junk" bond, the CDO, or the "perfect" technique for arbitrating Japanese equities, the "can't lose" hedge fund, the highly leveraged "conduit", what causes the inevitable collapse is "the unknown unknown", some far off and seemingly unconnected event, as when a nervy market suddenly learns that some German bank has a balance sheet brimming with mortgages on homes in far flung locations in America.

When it happens, fear and panic are inevitable, and entirely understandable reactions which need to be assuaged quickly and unequivocally. Victorian commentators spoke of the "malignant fear" and of being "disconcerted beyond example" when The Corner House turned out to be built on sand and deceit.

When a problem looms today, life savings, pensions, the family home, the business, school fees are all suddenly at risk.

The public policy challenge is perhaps less in the "cure" – to bail out or not has to be assessed case by case with risk to the overall system the main factor – than in "prevention", in understanding what banks and financial houses are actually doing, in critical analysis of their so-called business models and perhaps more disclosure of what the lawyers call "Risk Factors" to the investing and depositing public.

Even the fabled Medicis suffered huge losses and "runs" on their banks, and inevitably at the next peak in our own cycle, there will be more. Free markets work, but can be painful, and since human nature will not change, anticipation and prevention by street smart, grey-haired regulators may be our only remedy.

Geoffrey Elliott, a retired City and Wall Street banker, lives in Bermuda and authored The Mystery of Overend & Gurney, A Financial Scandal In Victorian London. This commentary first appeared in The Daily Telegraph in the UK.