According to Kathleen M. Howley from Bloomberg this is “the biggest jump in the London interbank lending rate in seven years could wreak further havoc on the U.S. housing market and there’s nothing the Federal Reserve can do about it.”

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 rate more than doubled after Lehman Brothers Holdings Inc. collapsed and American International Group Inc. struggled to stave off bankruptcy. If it remains elevated, it will boost the one-month to one-year Libor indexes that average the daily rate, said Keith Gumbinger, vice president of HSH Associates Inc., a Pompton Plains, New Jersey- based mortgage research firm.

“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 in an interview. “Even a small bump in the one-month rate will be additional stress on the marketplace.”

Rates on those home loans are beyond the reach of Federal Reserve Chairman Ben S. Bernanke and others on the Federal Open Market Committee, which is meeting today. The so-called 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 Adjustments

The overnight Libor ARM 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. 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.

Fed Meeting

The FOMC began its meeting this morning and is scheduled to announce its decision at about 2:15 p.m. in Washington. Policy makers have cut rates seven times from September 2007 to April 2008. They suspended the easing as oil prices surged, increasing expectations inflation would accelerate.

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.