The Post Office and local councils should fill the gap in mortgage lending left by the struggling banking sector, a former minister said today.

Chris Leslie, a former Labour MP and Constitutional Affairs minister, said there had been a "collapse of trust" in private lenders.

The Government should relax rules on council lending and encourage the Post Office to expand its range of loans to cover the mortgage market.

Mr Leslie, who is director of the New Local Government Network, a think tank, called for a return to the 1980s when 600,000 borrowers had council mortgages.

He said: "Local councils were once in the business of mortgage lending on a considerable scale."

"The government should consider using these and other agencies in its ownership far more actively than is currently the case

"The current economic downturn is not a 'classic' recession: it is heightened by the collapse of trust in the private banking sector."

In an article for next month's edition of Fabian Review, he argues councils would be better able to pass on lower interest rates to customers.

The deals would help families whose fixed rate mortgages had ended who were facing "punitive rates" from banks, he said.

He said rules that required councils to lend at a rate set by the Secretary of State were out of date.

"This rigid anachronism assumes an inability on the part of councils to think through for themselves competitive terms of benefit to their residents - and it should be abolished," he said.

"Second, councils should be actively encouraged by the Treasury to revive their mortgage role.

"Orthodoxy has accrued a reluctance to innovate in some local authorities and a Government green-light would give cover to the most conservative town hall treasurers."