IT was a humiliating day for a Coalition Government that had promised to overhaul the rail franchising system and end years of micro-management under Labour.

New Transport Secretary Patrick McLoughlin was left to admit overseeing one of the worst financial blunders to hit the rail industry since it was privatised under John Major's Tory government, and to order two reviews to help him put it right.

The debacle has already led to the suspension of three senior Department for Transport (DfT) staff responsible for awarding the franchise. There will clearly be calls for more senior heads to roll, but who?

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Justine Greening, who preceded Mr McLoughlin, or her predecessor Philip Hammond, who initiated the franchising overhaul?

There appear to be two obvious causes of this mess. One is a competence issue at the DfT, which has seen austerity-driven staff cuts at a time when its franchise department was log-jammed with renewals.

The other is a more fundamental problem with the franchising system, and one that is probably more difficult to solve.

The legal challenge by Virgin Trains, which has operated West Coast rail passenger services since 1997, to the award of a 13-year franchise to Aberdeen-based FirstGroup was based on the degree of risk inherent in the latter's bid.

FirstGroup had promised to pay £5.5 billion to the Government over the duration of the franchise, £700 million more than the bid tabled by Virgin. That's in today's prices – the real value of the payments, taking into account inflation and other factors, would have risen to more than £10bn.

The reason why Virgin bid less was because it was not confident of delivering the same level of passenger growth during the new franchise as it had seen in the previous one, when it had benefited from the new Pendolino trains and a £9bn upgrade to the West Coast Main Line.

Much of the company's uncertainty, as leading rail writer Roger Ford has pointed out, came from the feared disruption at London's Euston station from 2019, when work on the new high speed rail line (HS2) will limit platform availability. FirstGroup, headed by chief executive Tim O'Toole, was more bullish about the performance risk.

Virgin argued in its legal submissions that the DfT miscalculated the risk involved in FirstGroup's bid. Had the sums been done properly, it should have paid around three times the £190m subordinated loan it had put in place in case the franchise collapsed, Virgin claimed.

A key difficulty, and one inherent to the franchising system, is the crystal-ball gazing involved in predicting how the railway will perform in the future. This is the same problem that led to the collapse of the East Coast passenger franchise in 2009 as National Express walked away, having realised that it would not be able to afford the £1.4bn "premium" payments to the DfT due to a recession-driven downturn in passenger revenues.

Virgin boss Sir Richard Branson has claimed the same over- optimistic forecasts behind National Express' East Coast bid were repeated in FirstGroup's bid – and he can claim some vindication in the DfT U-turn.

The situation is very different in Scotland, where Government agency Transport Scotland sets the terms of the ScotRail franchise. It is notorious for micro-management, with clauses in place specifying everything from how clean the toilets and seats are to timetabling.

Ministers have also faced criticism for leaning towards a shorter franchise duration than that preferred by the industry – initially five years, although they eventually opted for a compromise of 10 years, with a five-year break clause.

With the possibility that both the East and West Coast Main Lines could end up back in Government hands and little clear direction over how they will be returned to the private sector, Scottish ministers will no doubt be far more confident in the relatively cautious approach they have adopted.