Jeremy Warner's Outlook: Politicians play the blame game, but everyone is culpable

Ronald Reagan once famously described a recession as when the guy next door loses his job. A depression was when you lose yours. The recession bit is already well on the way. They've taken their time, but all the lead indicators now point to a nasty and possibly quite prolonged recession.

Advertising spend is plummeting, oil and commodity prices are falling like a stone, and if you want to charter an aircraft or a ship, unavailable for love or money a year ago, you can now get one at the drop of a hat. Even the boom economies of the developing world are bracing themselves for a sharp downturn.

The good news, if any can be taken from the current calamity, is that policy action now being taken around the world to stabilise the banking system will in all probability prevent recession from turning into economic nemesis. Over the past two weeks, there has been a collective realisation that something dramatic had to be done.

The UK authorities have rightly won plaudits for the boldness of their plan announced on Wednesday, which even Hank Paulson, the US Treasury Secretary, has acknowledged as a possible model for others. He's now actively considering earmarking some of the $700bn (£410bn) Wall Street rescue fund for recapitalisation of US banks. Previously all the money was to have been used for buying up bad debts.

But though the Government deserves praise, the tragedy of this bailout is that the authorities had to wait until two, perfectly solvent, major banks – HBOS and Royal Bank of Scotland – were on the very brink of collapse before it did anything. The Prime Minister has said this week that no solvent bank will be allowed to go under for lack of liquidity.

What a shame he didn't make that plain a lot earlier. If he had done, the extreme crisis of confidence of the last week, culminating in the Government having to say it stood ready to recapitalise the banks as well as lend them all the money they need, might have been avoided. Political inaction helped turn a crisis into a near disaster which only the boldest of actions was capable of addressing.

Unfair criticism? Everyone has been on a sharp learning curve during this quite unprecedented banking crisis. A year ago, hardly anyone guessed how serious it would become. The authorities have been understandably reluctant to act as long as there was any possibility of a market-based solution. And it wasn't, in any case, until the collapse of Lehman Brothers a month ago that the banking crisis escalated off the scale. Prior to the Lehman's collapse, it had already been virtually impossible to get three-month money. Post the bankruptcy, even overnight money started to dry up.

Yet the die had been cast long before Lehman's went down, and when the history books come to be written it may well be decided that earlier action on liquidity and funding might have saved an awful lot of subsequent pain.

What is certainly true is the banking model being run at the top of the boom was with the benefit of hindsight highly unsafe. Heavy reliance on wholesale funding unbalanced traditional standards of risk assessment. It's remarkable how many financial commentators who thought bank shares a screaming buy two years ago when they were still riding high now say that the model was rotten all along and even at these depressed prices think of banks as now a busted flush. The problem arose because banks got used to using short-term, wholesale money – which was once in plentiful supply – for funding what they judged to be relatively riskless lending such as mortgages, credit cards and auto loans. As it turned out, these assets were a good deal riskier than assumed.

Yet it is not clear this was the fault of the "irresponsible" bankers now widely blamed for the crisis, in the political rhetoric. The root of the problem was the global liquidity boom, which the politicians rode as gleefully as bankers and credit-fuelled consumers. When money is washing around in the quantity it was, it finds a hole and creates trouble.

As house prices started to fall, loans that had been regarded as entirely safe became self-evidently more risky, transforming the shape of bank balance sheets. Banks had become so highly geared, or to use the jargon, "leveraged", that they simply didn't have enough capital to sustain the higher risk profile that was emerging in their loan books.

Banks have since become squeezed at both ends. The funding has dried up, so they they cannot sustain as much lending as they did. At the same time, the quality of the asset base has deteriorated. To make up the shortfall, banks need to raise more capital.

Is the banking crisis a problem of funding or solvency? It scarcely seems to matter any more. The two things are different sides of the same coin. The funding has gone, and for the time being, the taxpayer must fill the gap. Yet until everyone has confidence in the capital position of banks, the wholesale money markets won't return.

In the meantime, the opportunism of our politicians has become quite breathtaking in its audacity, with MPs from both right and left queuing up to condemn the bankers who once wined and dined them, and in the case of David Cameron, the Tory leader, are helping to fund his election campaign.

Excessive, irresponsible, City greed – not to be outdone, the soundbites fall from Gordon Brown's lips like confetti. He demands "punishment", yet where to stop is the problem. Personally, I've had quite enough moralising. Everyone is guilty in failing to understand the risk that the funding models of modern banking were building into the system, but none more so than the Prime Minister himself, who presided over and encouraged the illusion of economic prosperity that the easy credit of the capital markets delivered.

City must provide banks with their new capital

As bankers sit down with their advisers to decide on the best route to the recapitalisation now demanded by the Government, who's going to be first out of the hatches? Royal Bank of Scotland headed the rights-issue queue earlier this year, so it will almost certainly be attempting to claim "first mover advantage" this time, too. According to talk in the City last night, it may already be sounding out investors on another equity issue.

Yet this may be leaping ahead of the game. Until banks have sat down with regulators and established precisely how much capital is being demanded of each of them, there's not much point in dashing to the City to raise the cash. For the time being, there is a complete paucity of detail over what's required. What we do know is that the first tranche of £25bn referred to by the Government amounts to a 1 percentage point increase in tier-one capital for the named banks collectively. However, less well capitalised banks may be required to raise their ratios by more.

All seven commercial banks involved want to avoid tapping the taxpayer for the new capital if they possibly can. This shouldn't be a problem for HSBC, which is already relatively well capitalised and should have no difficulty in finding takers for any new preference stock required. But for the others it is plainly going to be tougher, and some may indeed need to fall back on government money.

Can RBS hope to avoid government dilution? It has already raised £12bn of new equity from shareholders. Since then, the shares have halved again. There is little appetite for more. Yet investors have no option but to cough up, despite the worry that it is only good money after bad. To allow the Government in, if only as a passive holder of preference stock, is a form of capitulation that stands significantly to dilute their stake in RBS's future.

Such is the extreme nature of the banking crisis that nobody much seems to care any longer where salvation comes from, so long as it arrives in some shape or form. Yet it is a terrible indictment of the City if investors cannot even provide the capital to ensure that Britain's major banks have a future, and instead abdicate this responsibility to the taxpayer. In such circumstances, what hope can there be for what once used to be thought of as the world's most successful financial centre. Investors must keep the politicians out by providing the money even for the beleaguered RBS and HBOS.

Regrettably for Sir Fred Goodwin, chief executive of RBS, the price will almost certainly be paid with his job. Most bankers are just victims of collective stupidity. Yet Sir Fred is the architect of his own downfall, having hubristically pursued the deal even as the credit markets were collapsing beneath him. The Government says it is not asking for his scalp as a condition of providing the new capital. The City is likely to be more brutally demanding.