IN an extract from his latest book, published in yesterday's Irish Independent, David McWilliams recalls his surprise on discovering that at the height of the banking crisis last September it was AIB, and not Anglo Irish Bank, that faced the most immediate threat to its existence.

During the course of a midnight discussion in his kitchen with Finance Minister Brian Lenihan, McWilliams was told that AIB "had the most severe funding problems. Ireland's biggest bank was actually our biggest problem . . . the bank that was pretending to be the most prudent was possibly the most delinquent".

Just over a year later, and what has changed? AIB exists today because the Government saved it from extinction, yet in style and in substance it remains as arrogant and as self-delusional as it was before the crisis exploded in our faces on September 29. It is determined to appoint one of its own executives as its new chief, resisting Government demands that it should recruit new blood; it hands out a wage increase to its employees while the rest of the country faces pay cuts and unemployment; and it is desperate to dilute the warrants that give the State the right to acquire 25 per cent of the bank. Instead of contrition, humility and gratefulness we get corporate swagger and corporate obstinacy.

McWilliams recalls that a "euphoric" Lenihan telephoned him the day after the blanket bank guarantee had been announced last September and catastrophe had been averted, for the moment at least. "I suggested that [Lenihan] should really go for it now. He could orchestrate a clean sweep of the old regime. I put the phone down, thinking that we were in a position of strength and hard decisions would flow from this, and the people who had brought the country to its knees would be brought to theirs. I expected our most delinquent banks would eventually go to the wall with the Irish State acting as broker, not principal, in negotiations between the bankrupt banks and their creditors. How wrong could I have been?"

How wrong indeed. Last week the legislation to introduce the National Asset Management Agency (Nama) bulldozed its way relentlessly through the Dail and remains on course to be enacted before the end of the year. As it grows from concept to actual institution, Nama becomes ever more opaque and ever more confusing. The more it is debated, the more questions that are asked, the less we actually understand.

Last week brought a detailed dissection of Nama's special purpose vehicle, a complicated construction that will be part-owned by private investors (the banks themselves, most likely) and which will exist so that the massive borrowings that the State must raise to buy the banks' property loans can be "hidden" off the State's balance sheet. So, presumably, no one will notice that we are on the hook for €54bn of borrowings, which will have been used to buy assets that are worth substantially less.

The future levy on the banks, which played a role in persuading the Green Party to back the legislation, has morphed into a tax on future bank profits, which is not the same at all. The other risk-sharing element of the deal -- also introduced after Opposition pressure -- appears under cross-examination to be far cosier for the banks than first envisaged and should not cause them too much pain. And even Nama's business plan, thrown together to justify the exercise and to show that Nama could make a profit, is described as "implausibly optimistic" by Dan Boyle, the Green Party senator.

The central flaw in the whole Nama concept shines as brightly as ever: it effectively rewards the banks for their previous bad behaviour, fails to extract proper compensation for the taxpayers who are taking the risks and allows the banks' investors to escape with far less pain than they should have been forced to take.

It is, as Lenihan told the Dail, a "relief" scheme for the banks: we consciously overpay and under-punish because that is what relief means. The only justification for such largesse is that nationalisation -- the likely outcome if we paid the banks a fair price for their dodgy loans -- must be avoided at all, though largely unspecified, costs.

In this the European Commission appears to agree with Lenihan, though others -- most notably the International Monetary Fund -- would be quite relaxed with an outcome that delivered temporary nationalisation while the toxic property loans were being cleansed. Unfortunately, the fact that nationalisation would be the likely result of a policy that put the interests of taxpayers ahead of bank investors allowed the Government to present it as an alternative to Nama -- and a nasty one at that -- rather than as a natural consequence if Nama were to do its job properly.

The current flaw in Nama -- its conscious avoidance of morality -- damages far more than the project itself, and puts far more than the State's €54bn at risk.

The flaw governs the rest of Lenihan's approach to the bank crisis -- extra billions for the busted shell of Anglo Irish Bank, extra billions for Irish Nationwide, the building society that turned into a property speculator on the most hubristic of scales -- and it comes against a backdrop of essential, savage cuts in the Government's current spending.

Tightening our belts while funding a fair and equitable bank rescue package would be tolerable; tightening them while bailing out the people who precipitated the economic crisis is not.

Lenihan's euphoria last September has seeped away and has been replaced by a robotic determination to shield the banks and their owners from the consequences of their actions. Hopes of reform have evaporated and AIB can look forward, with some certainty, to a future in which the crisis of 2008 and 2009 is little more than a speed bump in its corporate history, much like the Insurance Corporation of Ireland saga, or the Dirt scandal.

The only risks are if the Dail summons the courage to vote down the Nama legislation and this Government with it (as likely as turkeys voting for Christmas) or if some other crisis precipitates a general election and a change of government. Richard Bruton could not have been clearer last week when he talked of what Fine Gael would do if it returns to power. A Fine Gael government would not shirk from breaking up the bigger banks, he said. If a bank is too big to fail, it is too big, and never again must a bank be able to hold the State to ransom. Bruton is right: the banks have run rings around this Government throughout the crisis, dissembling and plotting and always resistant to change.

Their share prices soared when Lenihan announced his pricing strategy for their loans, confirming the generosity of the Nama deal, and they have tumbled back not because of Nama, but because all European bank shares have been hammered by the realisation that politicians will continue to force reform, even if this Government has lost the appetite. If European bank share prices fall, Irish banks will fall with them.

Last week's price collapse did, however, bring some benefits for the taxpayer because it removed the last chance that the banks might try to raise capital themselves before the end of the year -- a move which, if successful, would have cut the State's potential stake in half. The terms of the deal between the Government and the banks gives the State warrants that can be converted into up to 25 per cent of their shares, but about half of those warrants could be redeemed by the end of this year if the banks could raise private money.

No matter what objections are raised, Nama will trundle on. There will be more token concessions: on oversight, where Lenihan promises a role for the Oireachtas; and on ensuring that some of the billions snared by the banks flows back into the economy, with Lenihan promising "guidelines". Their tokenism will become apparent once Nama lumbers into life, its decisions and its operations cloaked by claims of "commercial sensitivity", while the banks duck and dive around the guidelines, using the taxpayers' billions to repair their balance sheet, not the broader economy.

Even worse, though, will be the lingering smell of a bailout for the institutions that brought this country to its knees but stayed off theirs. The Government faces immense difficulties in pushing through the spending cuts that it must deliver if it is to rein in spending, restore competitiveness and set the economy on course for recovery.

By choosing to make Nama a morality-free zone, where bad behaviour goes unpunished, AIB keeps its swagger and Anglo gets more billions, it creates a rod for its own back.

Nama, as currently constituted, undermines everything that the Government needs to achieve because it creates one law for bankers and their investors and one law for the rest of society.

It must change. It must exact a far greater price from banks' investors, putting the taxpayers' interests at the very top of its agenda, embracing oversight and transparency. It must become an instrument that rebuilds integrity by showing that bad behaviour is punished, not rewarded, and that morality has a place in the very heart of public policy.

Otherwise Nama, designed to save the banking system and help the economic recovery, will do far more harm than good.

- Alan Ruddock

Sunday Independent