The budget strategy of our country is now more than ever dependent on what happens next to our banking system. As has been apparent to anyone who cared to look over the past 10 years, the buoyancy of our tax revenues was uniquely related to the deluge of cheap credit; money flowed in, banks lent recklessly, tax revenues rose, the government budget went effortlessly into surplus, spending increased opportunistically to catch up with this abundance of funds in the State’s coffers and, not surprisingly, the national debt went down.

But that was then and this is now. Today, the deterioration of the government’s accounts is — conversely — driven by the collapse in credit and lending in the economy. You can’t fix the economy without fixing the banks. As a consequence, if you want to analyse the Budget you have to start with the banking system and the way credit is spread around the country.

On Sunday, the minister said that “we have nothing to fear but fear itself”. Whether this is true depends on his next move in the banking system more than anything he announced yesterday. Roosevelt saw the banks as part of the solution. Let’s hope Franklin D Lenihan sees things the same way.

The unprecedented banking packages announced by the EU in the past few days have put it up to the minister to inject huge amounts of cash into the Irish banks in return for equity.

At this stage, buying straight equity with taxpayers’ money would be the wrong thing to do. There are also calls for the Irish banks to merge as soon as possible; this too would be wrong.

Nationalising banks, despite the spin from London that everyone seems to have swallowed, is not smart.

There are many more creative ways of recapitalising banks and getting the best deal for taxpayers. Again, like the bank guarantee, Mr Lenihan, should look for an Irish solution to an Irish problem, rather than a cheap import from abroad.

It would be far smarter to lend money to the banks and charge them for it.

Most analysts say that Irish banks will probably need somewhere in the region of €10bn in new capital to cover the bad loans on their books and to begin to be able to lend again.

We could use the pension reserve fund for this. There is around €18bn in the fund and if this isn’t a rainy day, I don’t know what is. But most importantly, we could get the economy moving again, recapitalise the banks and make money out of such a move.

The State could inject €10bn into the banking system and charge the banks 9pc for the cash for a five year period. They are not going to get cash anywhere else at the moment so they would go for this option. This would imply the State would get €900m every year in interest income from the banks to pay for future pensions.

In addition, the State could negotiate a preferred share deal of 25pc of total bank equity, giving us, the taxpayers, huge upside.

The repayment schedule for the banks would be strict, so that if any bank failed to meet its payments to the Government, the State would take 70pc of the shares at a deeply discounted price.

In addition, the Government — as the most secure creditor of the banking system — could lay down terms, such as debarring Irish banks from lending abroad, limiting their exposure to property, forcing them to maintain a higher ratio of tier one capital and — most crucially in terms of democratic fairness — forcing the resignation of all the boards and senior management who got us into this mess in the first place.

The reason these individuals have to go is simple: to do otherwise would mean rewarding the guilty and by extension, punishing the innocent.

More significantly, capitalism works on rewards for a job well done and sanctions for messing up. To protect the reckless would signal to the world that Ireland is not a serious country. It would imply that Ireland is a crony backwater that got lucky and that the State is characterised by gombeenism at the highest level.

Foreign investors who will need to finance us in the future will just not find it credible. Investors will run a mile if they see that the same incompetents who waltzed us into this cul de sac and lined their pockets in the process, are still in power. In addition, for the morale of those working in the banks and for the sake of the next generation’s ambition, they too will have to see that there are opportunities at the top for those who do a good job, rather than for those who simply hang out at the right golf club.

In the same spirit of competition, we need to avoid too many hasty mergers in the banking system. The upshot of this recovery programme needs to be a decent banking system with as many players as possible, not a duopoly where the two big banks swallow up all the small ones.

At the moment, the Government, working on the advice of Merrill Lynch, appears to think that we can avoid recapitalisation by forcing mergers between the two big banks and the rest. This is atrocious advice. At the moment all Irish banks are operating below the critical tier one ratio of 8.5-9pc — which the European banks have achieved as a result of yesterday’s bailout.

This means that even merging them all together into a large super bank would still mean that the balance sheet is weak. Five poor balance sheets don’t make one good one! This would lead to big fees for the adviser and a Japanese-style depression for Ireland.

One has to also question the advice and objectivity of an investment bank, Merrill Lynch, which was bust three weeks ago, is AIB’s corporate broker and has also raised money for Anglo Irish Bank. In my opinion, it simply is too close to the discredited players to give clear counsel. The best way for the present management to survive this catastrophe is not to look for fresh capital and this might be why some of the main players do not want recapitalisation. In the interests of self-preservation, they are instead vouching for forced mergers, nationalisation and state protection for banks!

Mr Lenihan has been brave before; he should be brave again. If he injects money into the banks using a loan from the pension fund he will strike the deal of the century for the taxpayer. If he goes down the route of forced mergers, he’ll ensure his place in the pantheon of politicians who made a bad situation worse.

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