The warning from housing charities and Opposition spokesmen came as the Department of Social Security confirmed that the plan was one of a number of options being studied by ministers as part of the review of the welfare state.
Mr Lilley is concerned that housing benefit is spiralling out of control under current rules obliging local authorities to reimburse 'reasonable rents'. The cost will total pounds 8.8bn this year.
The DSS conceded yesterday that rent increases in a deregulated market were partly to blame, but ministers believe regional maximum rent ceilings could exert a downward pressure on the market.
John Battle, a Labour housing spokesman, said Tory housing policy had shifted the burden of housing provision into the private sector, but it cost an average of pounds 14.24 a week more to place benefit claimants in the private rental sector than in local authority housing.
Shelter, the housing charity, and other groups were quick to point out yesterday that the proposal would quickly exacerbate problems of rent arrears and homelessness caused by the current combinations of policies. Shelter said the plans would 'maximise misery for homeless families'.
While the housing benefit bill has increased more than five-fold, government spending on building social housing has halved in real terms from pounds 13.1bn to pounds 6.2bn.
Donald Dewar, the shadow Secretary of State for Social Security, said vulnerable tenants could be left homeless or stranded on local housing authorities' doorsteps.
Sir George Young, housing minister, was quoted in 1991 as saying Department of the Environment policy was clear: 'Housing benefit must underpin market rent.'
But Richard Lloyd, Shelter's head of policy, said clients were already facing arrears and evictions.
Shelter has calculated that in 30 per cent of all claims, 'reasonable' rents assessed by local rent officers are an average of more than pounds 17 a week lower than the sums actually charged by landlords. But only reasonable rents qualify for the maximum 95 per cent reimbursement from central government.
1992 Rowntree Foundation research found that cash-strapped councils based housing benefit payments on the 'reasonable' rent in 86 per cent of cases, leaving tenants to find the difference from limited incomes or face arrears, eviction and homelessness.
People in 'over-large' accommodation, including the elderly and disabled, are also already penalised.
The Government is now reviewing homelessness legislation and plans further private provision.
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