We're expecting David Cameron to confirm this week that the coalition's plans for House of Lords reform are going to be dropped, after The Daily Telegraph learned last week that he'd failed to win around enough Tories to get the changes through the Commons. So what happens then?
Expect a lot of Lib Dems to be furious and for Nick Clegg to have very public moan about it, but my sense is that these will be crocodile tears, designed to resonate with the party grassroots. The decision to abandon Lords reform won't split the coalition or even cause substantial damage.
Privately senior Lib Dems acknowledge that Cameron has at least done his best to change minds among Tories, and suffered a painful rebellion over Lords reform in the process last month. Lib Dem ministers accept that without Labour's co-operation the plans would never have worked, and it's fairly obvious Labour won't budge.
Lords Reform Is Dead - Long Live The Coalition?
The death of Lords reform won't in itself lead a similar shelving of Cameron's plans to reform constituency boundaries, although these could still be in danger, if the PM fails to come up with something big and concrete to appease his coalition chums.
Attention will quite quickly turn to the need for Cameron to find new policies to appease the Lib Dems, now both attempts to change the voting system to AV and Lords reform have failed. There are a few options on the table for Cameron, none of them will be particularly easy to pull off and some involve a bit of pain for the Tory party. Here are some of the things we could see suggested:
A substantial raising of the income tax threshold
There is talk among some senior Lib Dem MPs of taking everyone on the minimum wage out of income tax. At current pay levels it would require the tax-free threshold to be raised from £10,000 to £12,000, a pretty big jump. It's nice and simple and would be very easy for the Lib Dems to sell at the ballot box, it comes with the small problem of being expensive at a time when the economy remains on life support.
It would also require a fairly major policy U-turn because it would have implications for the Granny Tax - pensioners have seen their tax relief frozen in the last Budget and they'd almost certainly have to be included in the threshold rise. After all, the government wants to simplify tax and end up with everyone on the same threshold.
My rough guestimate is that this would cost about £2-4bn a year, and it would have to be implemented in next year's Budget to be felt in people's pockets in time for the next election. It would have to be balanced out with a tax hike or spending cut elsewhere. Lib Dems might want to see the 50p tax rate reinstated. But this probably wouldn't be enough to plug the gap, and as U-turns go would be an excruciating one for George Osborne.
A tougher approach to bank lending
Business secretary Vince Cable has made it a personal crusade to fix bank lending to small businesses, something despite their protestations the government believes the industry is still failing to do. So far the approach by Cable has been more about carrots and less about sticks, but Cable's rhetoric on this has become tougher recently. He described the banks as "anti-business" back in June, just before the Barclays LIBOR scandal first broke.
Vince Cable is determined to get the banks to lend more to small firms
Cable's private view is that unless the banks co-operate voluntarily the government should switch from carrot to stick, and he'd dearly love to be the minister wielding that stick. He's been thwarted so far in going further by George Osborne, but some kind of formal compulsion on the banks to lend seems easier to do politically, now the banks are about to be engulfed in a widening scandal surrounding their practices. The coalition would have to move fairly fast on this - the Banking Standards Commission set up by Parliament is due to report by the end of the year, with any recommendations leading to a possible tweak to legislation currently going through the Lords and due to arrive in the Commons in a few months.
A curbing of tuition fees
Lib Dems think the tuition fees hike at the start of the coalition has done more than anything else to damage their brand and cause them to suffer in the polls. They worry that this reneging on a party pledge at the last election has caused permanent resentment, particularly in university towns where Lib Dems have traditionally done well. There's strong evidence that it's also put a lot of people off going to university.
At the moment the maximum fee universities can charge is £9,000, and far more institutions went for the full-whack than the government expected. Any reduction would be cheered by Lib Dems, even if the final amount was higher than at the last election. It would be fiercely opposed by the leading universities and needless to say would be an embarrasing U-turn, but if the Lib Dems could show they'd fought for a reduction in government it could go some way to detoxifying their brand among key former supporters.
Party funding reform
There is talk that the Lib Dems still need something on constitutional reform, now they've failed to get AV and seem likely to lose the elected House of Lords. At the moment all parties acknowledge that the system is failing, leading to a drip-drip of sleaze among the Tories and the constant refrain that Ed Miliband is being controlled by union barons. The Lib Dems aren't immune from criticism - one of their big donors turned out to be a conman. It all comes at a time when donations to political parties are falling, presenting a massive headache for all three.
The problem with party finance is finding a way of stopping big donors and unions exerting influence without introducing taxpayer funding. After all, it's not going to be a vote winner, standing on doorsteps and saying, "Yes, we've reformed political parties so you now pay for them."
Cameron also has a problem in that Ed Miliband swooped in and claimed the initiative on this several months ago, calling for a cap on donations of £5,000. Everyone thinks he was being disingenuous - there is no way the Unite union's members donations would be capped at £5,000, they'd all be urged donate directly instead as individuals. Nonetheless Cameron would be loath to do anything which it look like he was dancing to Miliband's tune. Another complication is that any change to party funding needs to be done with the agreement of all the parties, which dilutes any claim the Lib Dems might have on saying it was their idea.