Political donations and honours have been a toxic combination ever since King James I invented baronetcies - hereditary knighthoods - to raise money for the Crown four centuries ago.

So the latest row over wealthy individuals who made undisclosed loans to the Labour Party and were then offered peerages (three have withdrawn their names) is merely another episode in a long and often tawdry tale.

But this episode has several new, and explosive, ingredients. First, there is the apparent subterfuge. While all donations to parties of more than £5,000 have to be disclosed- thanks to a law proposed by the Blair Government itself in 2000 - this does not apply to loans made at commercial rates. This is a grey area where the spirit, if not the letter, of the law is breached. All parties, notably the Conservatives as well as Labour, have engaged in this practice.

Second, there has been the clear relationship between big donations and honours, particularly peerages for those giving Labour a £1 million or more. Tony Blair argued today that, while making a big donation should not be the reason for making someone a peer, it should not be a reason either "not to put them in the House of Lords". Yet several of these wealthy donors who have been made peers have made little contribution to the Upper House. Again, this applies to all the main parties.

Third, deep divisions have emerged between Labour and trade union officials, notably between Jack Dromey, the Labour Treasurer, and No 10 and particularly Lord Levy, a close friend of Tony Blair and the party’s main fund raiser among big donors.

Mr Dromey’s outspoken complaints that he had been "kept in the dark" about the loans despite being Treasurer has caused a furore at Westminster, especially since he is seen as a close ally of Gordon Brown. His wife, Harriet Harman, has relinquished her responsibilities for electoral matters and House of Lords reform as a result of the row. It is also rather puzzling since the Blair camp claims the loans are in the Labour accounts.

The row has been damaging for Mr Blair, who has been widely seen by his Labour critics as being too close to "big money". Consequently, he decided to counter-attack today by saying he was considering changes to take the politics out of the honours system, and establishing a new independent adviser on ministers’ interests (a response to the problems of Tessa Jowell over the business interests of David Mills, her husband, from whom she is now separated).

Mr Blair also said that loans should be treated in the same way as donations, while there should be a fresh look at enhanced state support and a cap on donations. The next stage of Lords reform would, he said, look at the whole system of appointments.

There are no simple answers: parties have to raise money, and voters are reluctant to see even more taxpayers’ money given to parties. That is why all parties have increasingly turned to wealthy individuals for support.

The affair has sidelined and hurt Mr Blair just when he has overcome a major hurdle over his school reform legislation and wants to highlight further changes to public services.

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