Our political leaders must make the right decisions in the budget or face economic chaos.

At today’s cabinet meeting on the budget, the government must start to face up to the crunch decisions it must make.

Ministers face the most important financial choice taken in the past three decades. If they make the right one, our financial institutions and our economic reputation will be greatly enhanced. If they make the wrong one, there is likely to be pressure on the Irish banks, leading to chaos and, ultimately, political instability.

The discussions on the shape of the October budget are one thing. But the crux of the issue facing us is in the financial sector; it is that our banks have run out of money. This is how my dad would explain what, in financial markets, is grandiosely termed a ‘liquidity problem’.

In addition, there is no point pretending that this problem is limited to ‘weaker’ banks. All Irish banks are in the same boat – the only difference is how critically they are affected.

If the banks go, our economy goes too. All banking systems act like the heart of the economy. Without a strong banking system that pumps credit into every nook and cranny of the economy, activity dries up and the country dives deeper into recession. Recessions lead to depressions when banks are not able to lend and customers and businesses are not able to borrow.

Therefore, it is crucial that the government take the right decision now. Events of the past few days imply that there is no model we can import from anywhere else to help us. The rest of the world is suffering the same plight. Large banks are going under by the day. Thus, if we wait, we will simply suffer more.

We need to come up with an Irish solution to our specific problem – because no one has the antidote to the contagion that is spreading through the global financial markets.

While, in the longer term, Irish banks have bad debts/asset problems due to excessive lending to property, the problem that will drive them to the wall is short-term liquidity. This is what the state must rectify. We have seen from the US that the policymakers are making it up on the fly, hoping that by buying up toxic assets (bad debts), they can insulate the system and buy time.

However, as we can see from the rolling bankruptcies, this is not working – or, at least, only partially so. The challenge for Ireland is to come up with our own rescue model and then export it, rather than wait for some manna to arrive from heaven to solve our banking dilemma.

The only option is to guarantee 100 per cent of all depositors/creditors in the Irish banking system. This guarantee does not extend to shareholders who will have to live with the losses they have suffered. However, it applies to everyone else.

If the minister does this, he will not only staunch any funds outflow, he will show leadership and be seen as someone who is coming up with a solution that can be copied all over the world.

Ireland in the past has done things that no other country has done, to great effect. Think of the zero tax rate on exporters in the 1970s and the 12.5 per cent tax rate on multinationals now.

These were solo initiatives – we didn’t wait for them to work in other countries, and they worked perfectly well here. This proves that we can think for ourselves. Once more, and possibly even more crucially, we need to think for ourselves now. Furthermore, the state could charge the banks a 0.25 per cent fee for the guarantee, thus making about €1.5 billion per year in revenue (0.25 per cent of €500 billion).

If we take second-hand, discredited ideas from abroad, such as a toxic fund or, worse still, nationalising a bank, we will fail. If we fail, our banking system will be imperilled and a generation of Irish people will suffer. A failed banking system is equivalent to a failed state, and Ireland will become an international pariah. No politician can or should survive such a mistake.

The reason nationalising a bank will fail is that it will alert investors – those of us at home and foreigners who are crucial to the banking system – that the Irish banking system is in tatters.

The question then becomes, ‘who’s next?’ This will lead to contagion, and the system unravels.

There is another reason for not nationalising, and it is taxpayers’ money. Once you start using taxpayers’ money, you have to be careful. The lesson from the US in the past week is that using taxpayers’ money is unsuccessful and deeply unfair.

The beauty of guaranteeing deposits is that you use no money – not a penny. Instead, the government is using its sovereign credit as the country with Europe’s lowest debt/GDP level to restore confidence in the system. The civil service view appears to be that such a guarantee would subject Ireland to the risk that people withdraw money, disbelieving the state.

But this would not happen. Some €350 billion of the total €500 billion is held by Irish people, so we won’t move our cash. In addition, the €150 billion owned by foreigners would simply become like an Irish government paper.

The Irish bond market has never been in such demand, and so would this guarantee scheme.

In fact, it is highly likely that money would flow into the Irish banking system from abroad to avail of the guarantee. If you doubt that, look at Northern Rock, which is now receiving deposits from Irish people who are taking their money out of Irish banks.

Why? Because the British government is guaranteeing all Northern Rock’s deposits. Precisely the same would happen here.

Because the international financial system is in tatters, only the government can restore faith. No banks, no fancy footwork from financial whizz kids, no clever use of the bond markets can restore confidence. The market is suffocating and needs clear air passages. This means clear, unambiguous leadership and simple straightforward solutions.

This is the stuff of politics and the type of decision that most politicians would love to be in a position to take. Lenihan should regard the crisis in the banks as an opportunity, not a threat.

Last week he went some of the way. In its press release, the state implicitly guaranteed all deposits when the minister said: ‘‘The government is committed to the stability of our financial system, so that money placed with any Irish credit institution would not be at risk.

‘‘The Irish government wants to protect the whole financial system, secure its stability and ensure that all deposits in Irish financial institutions are safe.”

The key here is ‘‘all deposits’’. If an Irish institution went bust, would depositors with more than €100,000 have the right to hold the government to its ‘‘all deposits’’ description in this press release?

If the crisis leads to any loss of deposits, you can bet the courts will be full of cases against the state.

The minister should simply state explicitly that the deposits are guaranteed and clear up any confusion.

Unfortunately, he is being advised by merchant bankers on the one hand, who are just interested in fees and don’t give a fiddlers about Ireland, and civil servants on the other, who can’t see that nationalising a bank is the biggest policy reversal since TK Whitaker.

He needs to be brave and visionary and see through the limitations of his advisers. Equally, the careers of everyone around that cabinet table will be blighted if the banks go under as a result of any nationalisation plans.

They have collective responsibility. The decisions facing the cabinet are the most momentous any government has had to make in this country for many years. The right one for Ireland is a 100 per cent guarantee of all deposits.

Let’s hope, for all our sakes, that wisdom prevails. The alternative – influenced by vested interests and incomplete advice – is too awful to contemplate. The choice is between a recession, which is already here, and a depression, which might be around the corner. It couldn’t be more simple or more stark.