Is the Federal Government playing with fire?

If investment bank UBS is to be believed, it risks shaking the foundations of a sector which could bring the economy to its knees, that it could be the pin that bursts the housing bubble.

After the recent run of lacklustre earnings results, UBS veteran banking analyst Jonathan Mott thought the glory days for the banks may have passed, even before the new levy was announced in the federal budget.

But the new impost adds another dimension to the risks facing Australia's banking sector. And the banks are the gate keepers of the property market — a sector which is worth more than $6 trillion, nearly four times Australia's GDP.

Like it or not, residential property has become the bedrock on which the economy rests.

As interest rates sank to record lows, Australians were busy piling their wealth into houses, not businesses or assets that might enhance productivity.

Forget the mining boom unwinding, if property collapses, it's game over. A recession is a given.

All this is not to say authorities and policymakers are not right to attempt to slow the runaway train which is the property market. If left unchecked, it will inevitably destroy the economy anyway.

Policymakers have already enforced a partial credit squeeze to tame the market. Ordinarily, you'd expect cries of outrage from the finance sector, but it's been a boon for the banks because they've been able to lift interest rates.

Still, it is a hit to the property market. Now the banks will feel some pain through the Federal Government's levy.

Make no mistake, it will be passed on.

If banks choose to target the pain where they have the most market power, home borrowers will pay. Another hit to real estate.

A case of be careful what you wish for?

UBS says the levy has opened a Pandora's box. Banks putting up interest rates to mortgage holders could easily earn the wrath of the Government which may react by increasing the bank levy rate. UBS reminds us the UK bank levy was hiked nine times.

The report says: "Future governments could also raise the bank levy as an easy source of revenue to fund spending, tax cuts or the deficit, especially as none of the political parties oppose this policy."

It would further dilute an independent reserve bank's control over the economy if the government could force banks to lift interest rates through higher levies.

Not that governments are in the business of deliberately jacking up interest rates.

UBS is concerned about a perfect storm; the pressure of the levy, combined with households squeezed by anaemic wages growth, higher power bills and too much debt (particularly as many transition from interest-only to interest and principle loans).

So UBS sees a substantial risk to what it calls the Australian housing bubble.

There's no doubt the Federal Government is on a winner here backed by a cheer squad including most of the Australian population. Let's hope it's not a case of be careful what you wish for.