The verdant olive groves of northeastern Corfu, which obscure the stuccoed villas and the view of yachts moored along the coast, are not a world used to celebrity attention. This is precisely why they are a regular haunt of the reclusive wealthy.

On the only road between Aghios Stefanos and Kerasia, is the villa of Jacob and Serena Rothschild, scions of the banking dynasty. The odd snippet of life beyond the walls has crept into the public domain - it boasts a marble enclosed pool, artificial waterfalls and, according to the owner, “one of the most spectacular marine views in the world”. But for a decade it has remained a secluded retreat for the Rothschilds, free from prying outside eyes.

The return of Lord Mandelson, the Rothschilds’ close friend, to government at the start of this month has, however, sparked an extraordinary firestorm that has put events on the island this summer at centre stage. These tit-for-tat allegations have devastating consequences for the reputations - and the friendships - of those involved.

They exploded a week ago when The Sunday Times reported that Lord Mandelson had stayed on the yacht of Oleg Deripaska, Russia’s richest man, who built his fortune in the aluminium industry.

Lord Mandelson first said that he was merely attending a drinks party hosted by Mr Deripaska. He then said that he had last seen Mr Deripaska at a dinner hosted by Rupert Murdoch in Corfu. Mr Murdoch, chairman of News Corporation, which owns The Times, was in the island for a family gathering to celebrate the 40th birthday of his daughter Elisabeth.

It subsequently emerged that Lord Mandelson and other guests were “billeted” on board Mr Deripaska’s £80 million yacht because Nathaniel Rothschild, the hedge fund manager and son of Lord and Lady Rothschild, had run out of room at his house.

Lord Mandelson’s decision to stay on the yacht, with its 21 crew, has prompted questions over whether he has been too close to the aluminium tycoon, and whether their relationship had any bearing on his role at the time as EU Trade Commissioner. Lord Mandelson and the commission have strenuously rejected this.

A week earlier, it had been revealed that Lord Mandelson and George Osborne, the Shadow Chancellor - supposedly political enemies - met for dinner on the island. They were said to have compared notes on Gordon Brown at a £50ahead family-run restaurant, the Agni taverna.

Lord Mandelson allegedly told the Shadow Chancellor that Mr Brown had presided over a “culture of debt” and was said to have “dripped poison” into Mr Osborne’s ear. This was weeks before he accepted Mr Brown’s invitation to join the Government. When confronted on television, Mr Osborne refused to discuss details of the “exact private conversation”. But he added: “Let me just say it’s very surprising to hear him say he’s joined at the hip with Gordon Brown. And if the problem with this Government is it’s divided and dysfunctional, bringing Peter Mandelson in is going to make it more dysfunctional and more divided.”

Mr Osborne’s behaviour caused apoplexy, with Lord Mandelson retorting the same day that he also had dirt to throw from their heart-to-heart. “I would no sooner talk in public about what he said to me about his colleagues than I hope he would about what I said about my colleagues,” he told Sky News.

But friends of Lord Mandelson have continued to hint that Mr Osborne may come to regret his behaviour in Greece. Ben Wegg-Prosser, Lord Mandelson’s former aide, wrote in his blog last week: “I suspect the last thing that either Peter Mandelson or Oleg Deripaska needed this week was a media feeding frenzy about what they did last summer (thanks to George Osborne’s blabbermouth, Peter’s vacation has now dominated two weeks’ worth of Sunday newspapers, anyway, that’s another story in itself, and one which George will come to regret I suspect).”

But it is the third act of the Corfu saga revealed by The Times today - and which both Lord Mandelson and Mr Wegg-Prosser may have been hinting at in recent days - that could prove to be the most damaging.

It began when Mr Osborne was staying with Nathaniel at the Rothschild villa.

Mr Rothschild, 37, is not only the heir to a £750 million fortune, but is wealthy in his own right.He manages funds worth £11 billion through the Atticus hedge fund and has apparently accrued much of his wealth through his role as Mr Deripaska’s adviser. He also has friendships that traverse the political divide.

His ties with Mr Osborne are deep: they went to Oxford where they were in the Bullingdon Club together. And, perhaps most revealingly, they appear side by side in the 1992 photograph of club members on the steps of Christ Church, Oxford.

The family ties with Mr Osborne go even deeper. Earlier this year it emerged that Lady Rothschild was a donor funding the Shadow Chancellor’s office: she gave £190,000 to the Tory party, all of which was passed to Mr Osborne’s office.

Conservative sources said last night that Mr Osborne was staying with Nathaniel Rothschild and had suggested that he invite Andrew Feldman, the Tory party chief executive who was staying nearby, for a drink. Mr Feldman joined them at the house.

The sources said it was Mr Rothschild’s idea that Mr Feldman meet Mr Deripaska. They went on to his yacht but Mr Feldman vehemently maintained that there was no conversation about funding.

They disclosed that, on September 18, there was a telephone conversation between Mr Feldman and Mr Rothschild in which the latter suggested that Mr Deripaska wanted to make a donation to the Conservatives through his company Leyland Daf.

A discussion took place about the prospect of a £50,000 donation to the Tories from the Russian, although it was never made.

Mr Feldman - one of David Cameron’s oldest friends who was appointed to his fundraising role in May - will have been very aware of the electoral law banning donations from a foreign citizens.

But it seems that what happened after Mr Osborne returned to London - and started discussing his Corfu holiday - managed to upset his long-standing friend Nathaniel Rothschild so much that he decided to make public damaging claims about their conversations.

But few can have expected events to unravel in quite the way they have. One thing is certain: when Chris Grayling, the Shadow Pensions Secretary, went on the attack against Lord Mandelson for being “flustered” while answering questions over Mr Deripaska, little did the Tory high command realise that they would soon be on the spot themselves over connections with the very same man.

What the rulebook says

- Donors to UK political parties must be on a UK electoral register

- A UK-registered company that is incorporated within the European Union can also give money

- All donations over £1,000 must be declared in a register at the Electoral Commission

- The law prevents UK companies being used as a front for foreign donors. The Electoral Commission rules say: “If the original source of the donation is someone other than the individual or organisation that transfers the donation, the individual or organisation making the transfer is acting as an agent for the donor . . . Transferring a donation to an agent must not be used to evade the controls on permissibility and transparency”

Source: Political Parties, Elections and Referendums Act 2000

Times Recommends

• Tower block death blaze ‘suspicious’
• Licence payers fund BBC chief's £8m pension
• Potter star falls victim to swine flu