Attempts to clean up the financial system have become more urgent given reports of the banking world returning to normal.

There are suggestions that Goldman Sachs and Morgan Stanley could agree to pay out $34bn of bonuses between them later this year. I caught up with a friend at the weekend who works for a bank in the US: “Everyone is expecting a bumper bonus season, it’s going to be hugely controversial when this comes out,” he told me.

Of course lending has not yet returned to normal. But banks have been able to profit from recovery surges in some markets, for example stock markets outside Europe and the US. Soon it will be champagne time on some trading desks.

Today’s white paper on banking - issued by the Treasury - doesn’t seem to be greatly radical despite its broadly sensible tone.

1] It urges more sensible remuneration practices but fails to specify how pay and perks should be curtailed in any detail. The paper says “the FSA now has powers to penalise banks if their pay policies create unnecessary risk“. Every year the City watchdog will have to report on how banks are complying with a remuneration code of practice.

It will also “integrate oversight of remuneration policies into overall assessments of risk.” The Treasury is briefing that this means that banks with over-generous pay packages will have to hold higher levels of capital.

But how will they define “unnecessarily risky” pay packages? Herein likes the difficulty. I’m told the Treasury discussed the idea of a “maximum wage” and quickly realised it was unworkable. Let’s wait to see how this works in practice.

2] Alistair Darling (here is his speech today) will give the FSA a new statutory responsibility for financial stability but will otherwise leave the tripartite regime (Bank of England, FSA, Treasury) intact.

3] There will be a new “Council for Financial Stability” which will supervise meetings, three or four times a year, between representatives of the three bodies (who already meet regularly). These gatherings will be minuted and those minutes will be made public.

4] The FSA is strengthening rules to make sure banks hold enough capital as a buffer against losses.

Andrew Tyrie, a Tory MP on the Treasury select committee, said the white paper was “Rearranging the three key deckchairs on the Titanic”. There were questions as to why Mervyn King (governor of the Bank) only saw the report last week.

It was Lord Myners who hit the nail on the head when he told the committee this afternoon: “No amount of supervision will guarantee that you will make up for poor governance, poor management and a poor culture (at banks)”.

It is a difficult circle to square:

Ministers want banks to be responsible and risk-averse. They also want them to provide more loans for families and businesses.

The two are contradictory.

We had another insight into this puzzle this morning when the FSA, Lord Myners and John Healey (housing minister) were up in front of the Treasury Select Committee.

You may remember that Gordon Brown wants to ban 100 per cent mortgages. (”A new era of responsible lending“). The prime minister has asked the FSA to examine the issue. The watchdog is putting out a paper in the autumn examining whether mortgage restrictions are a good idea.

But the FSA executives who appeared this morning at the committee seemed far from enthusiastic about setting restrictions on loan-to-value or loan-to-income ratios.

Jon Pain, managing director of retail markets for the City watchdog, said that imposing “caps or collars” on mortgage lending based on income or deposit ratios could be a crude tool for measuring affordability.

Instead, lenders had more sophisticated ways to work out whether a household could repay a home loan, Mr Pain said. Assessing a loan on the basis of income versus mortgage was a “superficial” ratio, he said.

Mr Pain said that the level of a household’s disposal income - after paying mortgage payments - was a more appropriate figure than loan to value or loan to income ratios. (An argument used by many lenders in recent years to justify their more “liberal” lending practices).

Meanwhile another FSA executive, Leslie Titcomb, argued there were concerns about the potential impact on first time buyers.

“We are also concerned that having a fairly blunt tool like a cap on loan to values could have an effect of denying first time buyers access to the market, which would be unfortunate,” she told the committee.

Maybe I’m over-interpreting here but that seems pretty clear…..no ban on 100 per cent mortgages or banks lending six times your salary.

Sally Keeble, a Labour member of the Treasury select committee, said the comments proved that there was a “clash” between the two arguments.

“I’m fairly certain there is a clash about what the government wants to do,” she told the FT. “On the one hand, they want to see prudent lending, which argues for tight controls on loan to value ratios, on the other, they want people to be able to get loans.”

The charge against Gordon Brown is that his promise of future investment - instead of cuts - is cloud cuckoo land given the grim public finances. You may think this unfair.

But here is the verdict of the governor of the Bank of England today when asked about the national deficit:

Mervyn King:

“The speed of which the fiscal stimulus should be withdrawn has to depend on the state of the economy. …The scale of the deficit is truly extraordinary. 12.5 percent of GDP is not something that anybody would have anticipated even a year or two ago. And this reflects the scale of the global downturn.

But it also reflects the fact that we came into this crisis with fiscal policy itself on a path that wasn’t itself sustainable and a correction was needed.

There will certainly need to be a plan for the lifetime of the next parliament, contingent on the state of the economy, to show how those deficits will be brought down if the economy recovers to reach levels of deficits below those which were shown in the budget figures.”

Some grim developments on the public finances front. Alistair Darling prepares to acknowledge the biggest forecasting error ever made by a British chancellor (he takes the crown from Denis Healey). The IFS calculates that we’ll have to find £39bn a year in extra taxes or spending cuts till 2016, just to plug the fiscal black hole. And, perhaps scariest of all, one of the most powerful UK hedge fund managers warns that the “only policy option left” for Darling is to print lots more money.

This is not a cheap audition to be the next George Soros. Mike Platt, co-founder and chief executive of BlueCrest, Europe’s fifth-largest hedge fund, is a serious figure who usually shuns the limelight.

He predicted quantitative easing would be required six months before the Bank of England fired up the presses. Now he and other hedge funds are betting that Britain will have no choice but to print its way into an inflationary spiral.

This is the key quote from his interview with James Macintosh:

“The easiest way for the system to be saved is to print money. It is the only policy option left.”

Ever wondered what the IMF would demand from Britain? Simon Johnson, the former IMF chief economist, offers a good guide to an organisation that “specializes in telling its clients what they don’t want to hear”. His piece in the Atlantic runs through a typical IMF solution for the US, but most of the points apply to the UK too. Here’s the nub of his argument, which would be painful reading for Gordon Brown and “oligarchs” in the City.

Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.

Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause—Lehman was small relative to Citigroup or Bank of America—is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington….

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

He goes on to recommend that the big banks that helped lead the economy to ruin are broken up.

The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

If you want to see a critical response to the article, Dani Rodrik makes some convincing points.

His allies admit it will have to happen. Ministers just think he should just get on with it. The Tories, meanwhile, are licking their lips at the prospect of Gordon Brown stubbornly refusing to give way. The longer he holds out, they say, the more painful the eventual capitulation will be. The pressure is building. At some point, Brown may be forced to break the unspoken golden rule of his political career and say sorry.

It is unlikely to be straightforward. When it comes he will probably admit that mistakes were made, or some suitably unspecific formulation. But it will be the gesture of “humility” that even the Alistair Darling now says is required. In his interview with the Daily Telegraph, the chancellor takes the significant step of acknowledging that everyone — even his predecessor — must accept some responsibility for what went wrong. Blaming the US, subprime bankers, global forces or shirt-sleeved speculators will no longer wash with the public.

The chancellor seems to be playing the unlikely role of cabinet outrider, by daring to speak uncomfortable truths. After his last big interview with a feature writer in late August, Darling was pilloried for suggesting the world economy was in bad shape. He is now, perhaps, pre-empting the blast of public anger that could soon target under-achieving politicians instead of overpaid bankers.

Will Brown eventually admit to mistakes? His speech to Congress would have been a good point to do it, given that he would be surrounded by lawmakers who are arguably more culpable than him. But there are still no signs of him giving in. Brown today told aides that an apology would just bring a hammering from the Tories. This may be true. The danger is that Brown will look increasingly out of touch as he stands alone waving a ‘no surrender’ flag.

Here are the key Darling quotes:

There are a lot of lessons to be learnt by regulators, governments, all of us. The key thing that went wrong was a culture was allowed to develop over the last 15 years or so where the relationship between what people did and what they got went out of alignment, especially at the top end.

If there is a fault, it is our collective responsibility. All of us have to have the humility to accept that over the last few years, things got out of alignment.

“There are some very hard questions to be asked about the regulatory model we have operated for the last few years. The model of us saying to [the bankers] ‘you say it’s OK to us and we’ll go along with it’ has failed…financial services have to be properly run and supervised.”

We’re all looking forward to Gordon Brown’s lecture speech to the joint session of Congress on Wednesday. This is his big chance to tell America’s lawmakers that they were responsible for the global financial crisis. His regularly repeated thesis, after all, is that the economic catastrophe started in the US (because of lax national regulation) and infected other economies (because of lax global regulation). He’ll surely take this opportunity to tell Congress how it is, to their face - won’t he?

There are plenty of past sound bites for his speech writers to choose from. Here’s a selection.

“It started in America, there was a lot of irresponsible lending taking place, a lot of it was completely unknown to the authorities, and people were passing the risks on from one person to another and a lot of them ended up in Europe. So it’s a problem of the banking system that has started with the tragedy of the sub-prime housing market in America.” BBC Politics Show, October 2008

“This problem started in America. They have got to sort it out. The Americans have a responsibility to the rest of the world.” Sky News, October 2008

“What caused it was not something that happened in Britain….I think everybody understands, even the Americans now say, this is a global problem that started in America…” BBC, November 2008

“I think everybody recognises that this problem started in America.” Downing Street press conference, January 2009

“What I regret is that we have been unable to remain unaffected by a global downturn and the.. events that started in America.” Downing Street press conference, December 2008

“I’ve been angry about the behavior of banks, starting with the sub prime market in America.” BBC, November 2008

“But what I do say to you is, this is an international crisis, it’s global, it started in America. We’ve had very little control over…” BBC, November 2008

“That is why, when threatened by the global financial turmoil that started in America and has now spread across the world, we in Britain took action to secure our banks and financial system…” Times, October 10

One of our readers is clearly upset. I’ve just been sent a diatribe against the (Tory) claim that it is cheaper to insure the debt of McDonalds than Britain. Here’s the sanitised version:

I’ve been gnashing my teeth over one oft-repeated claim because it’s made me repeatedly angry - and sadly won’t die. I refer to the moronic argument (pushed by George Osborne) that McDonald’s has a better credit rating than the UK government. It is now repeated endlessly by Guido Fawkes and Fraser Nelson.

The UK has a higher CDS spread than McDonald’s - true. 160 for the UK vs 55 for McDonalds at 5 years. Then again, the US government is at 90 points. This shouldn’t survive a knock test.

- McDonald’s latest bond issuance was only rated at A by Fitch and the latest McDonald’s bond issuance traded at 270 bp over US treasuries, it doesn’t suggest these prices reflect real expectations of risk.

- It’s also not clear how these CDSs would pay out unless the UK or US opted into an Ecuador-style default. We can print our own money, lots of taxable capacity and - in any case - have a load of ways to renege on previous commitments which would not trigger CDSs (cutting pensions or infrastructure spending, for example).

- Finally, would the bond insurers survive a UK or US default? Would they actually offer any protection

It’s not really clear why they exist at all. There’s a neat Alphaville post on it. Bah.