For those who doubted the power of a flood of liquidity — provided by the world's central banks — to turn around depressed asset markets, the evidence is now plain for all to see. Over the past six months there has been a tremendous surge in many asset prices.

From Washington to Beijing the authorities opened the floodgates, like never before, to prevent a nasty recession from becoming something even worse. And, of course, financial assets are the first to be affected by cheap credit, before leakages occur into the real side of the economy, boosting output and employment.

There are some doubts about how well the damaged real side will respond to the stimulative measures, but policymakers are definitely keen on doing their best to get results. All of which raises concerns about the sustainability of autonomous demand growth, mistakes in policy exit strategies and the spectre of rising inflation.

The price rises are not only occurring among financial assets. Real assets are also reacting to the excess liquidity. Currently, some of the increase in real-asset prices is a result of investors seeking alternative stores of value.

It is less to do with any significant pick-up in industrial and housing activity, apart from the solid growth occurring in China. Evidently, there are underlying fears that authorities are treading a dangerous path in debasing their currencies.

The liquidity has brought happy smiles to many faces. With interest rates at zilch levels, increasing leverage and taking on risk is very tempting indeed. And in the business of trading, people are easily tempted when they see the opportunity of making fat profits dangled before them. Hedge funds, in particular, have been doing very well, taking advantage of the government largesse.

At the top of the heap is none other than Goldman Sachs. Within the firm, its proprietary desk constitutes one of the largest hedge funds around. And it is the prop desk that has been providing much of the performance. Over the past two earnings quarters, the firm has raked in a tremendous amount of money, and paid out huge bonuses to many employees.

This is the same firm that a year ago was on the brink of meeting the same fate as Lehman. But as vultures circled around, the government rescue plan robbed them of a tasty meal. You may remember that the authorities hastily turned Goldman into a banking institution, giving it access to cheap and plentiful funding from government sources.

The clever men at Goldman used the lifeline provided by the government to bounce back from the edge of oblivion, make fat profits, repay the loans and dish out obscenely high bonuses to their staff. What's wrong with that, you may ask? Didn't they act skilfully and therefore deserve their returns?

Well there is plenty wrong with this model of how to run financial institutions. Goldman and their ilk were instrumental in bringing on the financial crisis through their risk-taking activities. According to the rules of the market, they should risk their own capital and take the gains and losses as they come. Except that when the big losses occurred, they cried uncle; and sure enough uncle came to the rescue.

At the heart of the problem — apart from crony capitalism — is what sort of banks we should have and how big they should be. Many years ago, commercial banking was a dull and relatively low-return business, principally engaged in the process of transforming deposits into loans. And because of the essential nature of their business for the economy, banks were tightly regulated, and not much of what they did was hidden from view.

Then things became really exciting as changes in regulations allowed them to branch out into a variety of activities, with a finger in every pie. They dabbled in all kinds of fancy derivatives, created an assortment of structured products and set up special investment vehicles to fool outsiders. The profits came rolling in and bonuses were paid out, until the day when the risks undertaken overwhelmed their comparatively meagre capital and they went on public assistance.

How nice it would be if the baddies have learned a lesson and won't repeat their mistakes. What a pleasant thought that contrite bankers have finally confessed to their sins and are now pure again. Of course, the public relations folk will feed you this storyline. But everything we know about Wall Street and the City tells us that this is a fantasy.

Lecturing errant bankers won't reform them. It's the discipline of the market that works wonders in sorting out success from failure and teaching hard lessons. Saving bankers from punishment only encourages them to eventually plunge into even deeper pools of risky ventures, endangering the economy and the financial system, and occasioning another rescue attempt by the government.

The solution to this, as many people have proposed, is to separate ordinary commercial banking from other financial activities currently carried out by banking institutions. It is back to the old utility model of banking. A dull, low-return, highly regulated activity that is generally safe, stable and good for the economy.

The thrilling stuff can then be done by those firms with sufficient risk capital and knowledge to weather market vicissitudes without endangering the system, and without having ready recourse to public assistance. But, they too, need a degree of non-draconian regulation, which should be flexible enough to allow innovation and creativity. As for size, the big should be made smaller.

Iraj Pouyandeh is a strategist and senior portfolio manager at LOM Asset Management. He manages the LOM Global Equity Fund. For more information on LOM Asset Management please visit www.lomam.com