Just last month, the head of the Financial Regulator's legal department, George Treacy, came before the Oireachtas Committee on Finance and the Public Service to explain to befuddled lawmakers how and why bank customers were being charged thousands of euros to break out of fixed-rate mortgage contracts. The simple reason was that interest rates had dropped to historic lows and single variable-rate home loans were cheaper than ever.

After patiently walking the committee through the mechanics of loan pricing and net margins, Treacy gently reminded his interrogators that the present unusual rate environment – in which banks had been forced, by public and political pressure, to drive down the cost of borrowing to relatively unprofitable levels – was unlikely to persist.

"You may be back here in three or four years asking me why there is no fixed-rate market any more," he said.

Treacy was wrong: it took only a few weeks for the wind to change. Since Irish Life & Permanent jacked up rates last Monday on its 50,000 variable-rate mortgage borrowers by half a percentage point, the clamour now is all about the variable-rate customer. This poor soul is now vulnerable to the profiteering whims of bankers who, as we've been reminded by numerous TDs and consumer advocates, would be out of work without the largesse of the ordinary taxpayer.

Well, that's true. But it's not the whole story. First of all, people on variable-rate loans have always been vulnerable to surprising and painful rate changes. They're just more vulnerable now because the switcher market has disappeared with the virtual withdrawal from the mortgage market of foreign-owned banks such as Halifax and National Irish Bank, who repriced months ago. That means the domestic banks have a lot of room to go higher themselves without negatively affecting market share.

More importantly, because mortgage customers are also taxpayers, higher margins for the domestic guaranteed banks are actually cheaper in the long run. That's because, if the banks don't return to profitability, they can't pay us back for all the extra costs the state has to bear for the bank guarantee scheme, recapitalisation and Nama.

Yet suddenly, where people had once accepted that the rates banks charge could go up or down according to the interaction of competition and supply and demand, now people appear to believe the price of borrowing not only could – but should – be controlled, if not by government, then by some combination of shame and gratitude on the part of the banks.

"The contradiction we see mainly from politicians and union reps is that several weeks ago they were lobbying to allow people on fixed rates, who have a price promise, to break out of it with no penalty," said Karl Deeter, operations manager with Irish Mortgage Brokers. "Now several weeks later they want to see people on variable rates get fixed-style benefits, but the utopian situation in credit simply doesn't exist."

Last Wednesday's enterprise committee hearing with the executives from AIB and Bank of Ireland showed the way things are going. Chairman and Labour TD Willie Penrose, acting on widespread anger at IL&P's decision to raise rates, pushed the executives to guarantee their institutions would not follow suit.

But Robbie Henneberry, AIB's managing director for the Republic, and Bank of Ireland retail chief executive Des Crowley played for time. Both said their banks had no short-term plans to raise rates, but made no promises for the future. Henneberry admitted that a rise was inevitable, while Crowley simply declined to make a prediction.

However, it is unanimously accepted within the industry – from bankers to brokers to stock analysts – that margins at Irish banks are actually quite low and have to rise if the banks are to have a real chance of surviving the crisis and thriving in the future. The foreign-owned banks widened their spreads months ago, at once signalling their effective retreat from retail lending and clearing the way for domestic banks to follow.

Privately, executives from the covered institutions say rate rises across the board are just a matter of time: the difference between high deposit rates and low lending rates is too big and banks can't afford to cover it any more.

Irish banks actually have very thin margins as a result of this anomaly. The average interest rate margin for an Irish bank – the difference between what it charges on loans and what it pays for deposits – is just over 1%. That is around half of what British banks make. The typical US bank margin is almost five times as high. ECB rate cuts over the past year have made the situation worse as banks have been under enormous pressure to cut variable mortgage rates, but unable to cut deposit rates because funding is so precarious and the deposit market is so cut-throat.

Even the International Monetary Fund (see graphs) noted this in its recent country report on Ireland: "Irish interest margins were low by international standards. As the crisis has unfolded, margins have been under further pressure with the sharp decline in lending rates (especially for mortgages, which are predominantly on variable rate terms)". When lending volumes were high this was not a problem, but with less market activity low margins are a killer.

With a new survey last week from the Central Bank showing yet another contraction in lending, profitable margins have become even more important. The banks blamed an increase in the cost of funds and other financial constraints for tighter lending, two factors that higher rates would help overcome.

"It's a matter of basic economics," one senior banker told the Sunday Tribune. "The reason banks are not lending much is because margins are not high enough."

So the choice isn't between high rates or low rates. It is between lending or no lending, more profitable banks or zombie banks. Moreover, the whole rates furore has demonstrated why, in the long term, entanglement between the government and the banks is not good for either because their closeness conceals the fact that the banks are not being run for our benefit today, they are being saved for our benefit tomorrow. There is no benefit if they cannot afford to do business and, consequently, pay us back.