As Oxford University's bigwigs and donors cheered their boat race victory from their launch last Saturday, their delight was interrupted by a blatant fundraising speech from the vice-chancellor, Andrew Hamilton. Now, surely, he said, they should donate. I hope they give not a penny until that university has found the courage to face down the government on fees and gone properly independent, which is wholly within its rights.

If Oxford will not stand up for university autonomy, who will? The long road to scholastic subservience to the state began under Margaret Thatcher in 1988 and is approaching denouement. So far the only fixed point in the decline has been the gutless, whining, leaderless cowardice of university vice-chancellors and their boards. If a future historian wishes to chart the demise of the British university, this is the moment to start.

No account could do full justice to the absurdity of the coalition's so-called fees policy. To describe the rise from £3,000 to a maximum of £9,000 a year as "an increase in student fees" is simply wrong. The thousands of students who march against it are deluded. Student fees have been abolished by the coalition and replaced by a long-term loan with no down-payment, guaranteed by the government, funded by the taxpayer and reclaimed from taxation only when the graduate earns enough.

Only a third of the loans are expected to be repaid. This is a university voucher repaid from supertax – a Labour policy. Thatcher's children are marching not against fees but against middle-class taxes, though even these will not be as high as those probably faced by their parents before Thatcher came along.

The mystery is how ministers have allowed themselves to be bamboozled by their opponents' propaganda. They have wriggled and churned and tortured themselves to reduce the fees, ease the fees, subsidise the fees, when they know perfectly well there are no fees. The loan guarantee should be known as a "fee-grant". To be sure, if middle-class parents are stupid enough to save the government money by paying the fee-grant up front, no one can stop them. As it is, the exchequer is doling out billions of pounds in yet another middle-class subsidy for which ministers are not getting an ounce of credit. It makes Andrew Lansley's NHS reform look like a model of nuanced sophistication.

Now we move to scene two. The cost of these tripled fee-grants is to be met by cutting teaching grants. Thus hurled towards bankruptcy, a half to three-quarters of universities are said to be planning to charge near the full £9,000. Their plight is worsened by the Home Office seeking to withdraw £2bn in overseas student fees. In other words, what the government saved on the teaching grant it will more than lose on fee-grants, reputedly as much as £1bn. Even a Whitehall economist could have predicted that.

At which point Lewis Carroll enters. Vince Cable, the universities minister, is under huge pressure to staunch the haemorrhage from the exchequer. He has already threatened to fine any university £3,000 per student if it "over-recruits". A further fine will be imposed on any that "unreasonably" charges £9,000, or charges more than £6,000 other than in "exceptional circumstances". This zany inversion of Stalin's Stakhanovite system could only come from a brain softened by panic.

Meanwhile Cable's quango, the "office for fair access" or Offa, is operating on planet Zog. Unaware that the regime for poor students is the most favourable ever, Offa is trying to get more of the working classes into universities. Also with its eye on the now famous £9,000, it wants a large chunk of it, as much as £1,000, spent on "outreach" to the disabled, ethnic minorities and the poor. If this does not happen it, too, will ban or fine the £9,000. Offa wants universities to set and meet targets for retention rates and state school entrants, and says it can fine them up to £500,000 for a "wilful and serious breach".

Curiously the deputy prime minister, Nick Clegg, appeared to negate this by saying universities "haven't got permission" to raise fees unless they can prove their intake will "dramatically increase the number of people from poorer and disadvantaged backgrounds". This implies universities have no autonomous power to raise fees but must await an inspection, proof of widened access, and then permission. I gather the legal basis for this assertion is unclear.

At the last count, 90% of university outreach spending took the form of bursaries, in effect removing students from the loans bank and reducing the number who will ever repay anything. The tax system will thus have a bizarre new coding: above a given level of income, there will be one code for those whose parents were poor and a higher one for those whose parents were rich. This must be a new departure in fiscal socialism – and one created by a Tory chancellor.

The reality is that no one has defined the proper balance of financial responsibility for higher education between government, universities, parents and students. The government is splashing money and bureaucracy over students of all income levels and universities of all degrees of quality. The result is a centralisation of targets, norms and oversight that must render a university little more than an administrative outpost of the department for business, innovation and skills – a title that significantly does not include the word education.

Universities have spent 30 years selling their souls to the state in return for money. Faust's retribution is at hand. Some hoped a Tory government would uncap the fees and re-establish the autonomy that made British universities world leaders. The opposite has happened. There is no respect for any market, let alone one in quality. Nor is there any respect for academic or institutional autonomy; merely a Stalinist obsession with control.

But there is an escape. Universities are independent charities. They can charge what they like and call the government's outreach bluff, should it refuse bursary or loan support. Universities could organise and fund their own scholarships, sell their research in the marketplace, and base their appeal on the quality of their work. Nothing but their addiction to government money is forcing them to toe the Cable line.

If any university could afford to make the first move, it is Oxford. It could do so tomorrow if it had the guts. Its friends should give it money then, but only then.