About 6 million U.S. mortgages, including almost all subprime home loans and 41 percent of prime ARMs, are linked to the London Interbank Offered Rate, or Libor, according to First American CoreLogic in Santa Ana, California. Today's daily rate more than doubled, with smaller gains in the one-week and one-month rates, as lenders demanded higher compensation for risk after Lehman Brothers Holdings Inc. collapsed and the value of American International Group Inc. fell 84 percent in a week.

Daily Libor rates are used to calculate monthly adjusting mortgage resets, including some so-called ``option ARMs'' that allow borrowers to defer payments by increasing mortgage balances, said Keith Gumbinger, vice president of Pompton Plains, New Jersey-based mortgage research firm HSH Associates Inc. More importantly, gains in the shorter-term Libor rates may signal increases to come in the three- to 12-month indexes used to calculate the majority of ARM resets, he said.

``If this is more than a flare, if the rate remains high, there is no doubt it will have an effect on resetting mortgage contracts in the U.S.'' Gumbinger said. ``Even a small bump in the one-month rate will be additional stress on the marketplace.''

Home loan rates tied to Libor are beyond the reach of Federal Reserve Chairman Ben S. Bernanke and others on the Federal Open Market Committee, which today left its benchmark interest rate unchanged. Libor-indexed loans, including the subprime mortgages that helped spark the global credit crunch, have interest rates that are set by London bankers who report to the British Bankers' Association.

ARM Defaults

Forty percent of subprime adjustable-rate mortgages were either in foreclosure or had late payments in the second quarter, according to the Mortgage Bankers Association in Washington. For prime adjustable-rate home loans the combined rate was 12 percent and for mortgages of all types it was 9.2 percent, the trade group said in a Sept. 5 report.

U.S. home prices probably will tumble through 2010, Freddie Mac said in a forecast yesterday. The S&P/Case Shiller Home Price Index likely will drop 13 percent this year, 4.3 percent next year, and 2 percent in 2010, the MacLean, Virginia-based mortgage buyer said. That's on top of an 8.9 percent drop in 2007.

Combined sales of new and existing homes probably will fall to 4.92 million this year, 34 percent below the all-time high of 7.46 million in 2005, Freddie Mac said in the forecast.

The overnight Libor rate in U.S. dollars soared 3.33 percentage points to 6.44 percent today, its biggest jump in at least seven years, according to the British Bankers' Association. The one-week rate rose by more than a percentage point, to 3.88 percent from 2.49 percent on Monday, and the one-month rate increased to 2.75 percent from 2.5 percent.

Mortgage Resets

Many Libor-linked U.S. mortgages don't limit the size of a loan's first adjustment, with caps of 2 percent on subsequent changes. That means a monthly mortgage bill could double or even triple when it first resets.

``If the Libor market seizes up and stays that way, it's going to complicate everything,'' said Bill Fleckenstein, president of Fleckenstein Capital in Seattle. ``What you are seeing is the unwinding of the financial system as we know it.''

Banks tightened lending as AIG was downgraded by Moody's Investors Service and Standard & Poor's, adding to evidence that the fallout from the collapse of the U.S. mortgage market is spreading. The surge in funding costs came less than a day after Lehman's bankruptcy, the biggest in history, and Merrill Lynch & Co.'s sale to Bank of America Corp.

The Federal Reserve left its main interest rate at 2 percent today, its first unanimous decision in a year. The central bankers said they will continue to address market turmoil with emergency lending and use monetary controls with a long-term strategy aimed at promoting growth in the world's largest economy.

Fed Statement

``Tight credit conditions, the ongoing housing contraction and some slowing in export growth are likely to weigh on economic growth over the next few quarters,'' the FOMC said in a statement. ``Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity should help to promote moderate economic growth.''

Policy makers have cut rates seven times from September 2007 to April 2008. They suspended the easing five months ago as oil prices surged, increasing inflation concerns.

Yesterday, the federal funds rate soared as high as 6 percent, triple the Fed's target, as banks hoarded cash. That spurred the Fed to pump $70 billion into money markets through repurchase operations, the most since September 2001.

Premiums on investment-grade U.S. corporate bonds climbed. The extra yield investors demand to buy such bonds instead of Treasuries with a comparable maturity soared to 3.80 percentage points, the highest since Merrill Lynch began keeping the data in 1996, from 3.44 percentage points on Sept. 12.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.

Last Updated: September 16, 2008 17:08 EDT

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