July 11 (Bloomberg) -- A failure or government bailout of Fannie Mae and Freddie Mac could push mortgage rates above 7 percent for the first time in six years and delay a recovery in the U.S. housing market.

Home loan rates would go up by one percentage point, to about 7.3 percent, if the companies failed because borrowers would have to pay private market rates, said Keith Gumbinger, vice president of mortgage research firm HSH Associates in Pompton Plains, New Jersey. Even if the government steps in, rates could gain as much as half a percentage point as the cost of selling mortgage-backed securities rises, he said.

Fannie Mae and Freddie Mac, which own or guarantee about half of the nation's $12 trillion of home loans, have lost about half of their market value in the past week on concern the companies have insufficient capital to cover losses on mortgages they hold. The turmoil may limit the companies' role in reviving the housing market, said Mark Zandi, chief economist for Moody's Economy.com in West Chester, Pennsylvania.

``We were all counting on Freddie and Fannie to step up and get the housing market rolling again, but they've been completely overwhelmed by the subprime tsunami,'' Zandi said in an interview.

Sales of previously owned homes probably will drop to an eight-year low of 5.31 million in 2008, the National Association of Realtors said in a June 8 forecast. The median sale price is set to tumble 6.2 percent, four times the 1.4 percent drop last year that was the first decrease in the national median since the Great Depression in the 1930s, according to Lawrence Yun, the Chicago-based group's chief economist.

Late Payments, Defaults

Almost one in every 10 U.S. home loans had a late payment or had defaulted in the first quarter, according to a June 5 report by the Mortgage Bankers Association in Washington. The total inventory of homes in foreclosure increased to 2.47 percent and the delinquency rate, loans with payments 30 days or more overdue, grew to 6.35 percent. Both were all-time highs, the trade group said.

Mortgage borrowers will bear the cost of the higher costs the companies will be forced to pay to entice investors to buy their bonds, HSH's Gumbinger said. The difference in yields between the agencies' 10-year notes and 10-year U.S. Treasuries reached a four-month high this week. Fannie Mae's yield premium rose to 89.9 basis points and Freddie Mac's was 96. A basis point is one one- hundredth of a percent.

Likely Scenario

``The most likely scenario is Fannie and Freddie are still around, but their higher costs of raising capital will be passed on to the consumers,'' Gumbinger said. ``Any increase in mortgage rates will put pressure on an already-weak housing market.''

The average U.S. rate for a 30-year fixed mortgage is 6.37 percent this week, up from 6.35 percent during the first week of the month, according to Freddie Mac. The last time the rate was above 7 percent was April 2002 when it was 7.13 percent.

It wouldn't be the first time borrowers have seen an increase in so-called conforming rates because of the global credit crunch that began last year.

The agencies started passing on their higher borrowing costs four months ago when they began charging an additional, upfront fee of 0.25 percent of the mortgage amount. That added $1,000 to the costs of obtaining a $400,000 home loan.

The increase was prompted by ``continued deterioration in the mortgage market,'' the company said in a Dec. 11 statement announcing the move.

Shares Fall

Fannie Mae and Freddie Mac tumbled to 17-year lows in New York trading. Fannie fell $2.95, or 22 percent, to $10.25 and Freddie Mac fell 25 cents, or 3.1 percent, to $7.75 in New York Stock Exchange composite trading.

The current turmoil comes after five years of accounting scandals and management shakeups at the world's two largest mortgage companies.

In November 2003, Freddie Mac admitted understating earnings by almost $5 billion, ending a yearlong review that led to the ouster of two chief executives and the company's president. The company paid $50 million to settle with regulators, according to the Securities and Exchange Commission.

In 2006, the McLean, Virginia-based company paid $3.8 million to settle allegations it made illegal campaign contributions, according to the Federal Election Commission.

Accounting Errors

The Office of Federal Housing Enterprise Oversight in 2004 charged Washington-based Fannie Mae, the larger of the two rivals, with accounting errors that included shifting losses so senior executives could earn bigger bonuses. The mortgage agency in December 2006 restated its earnings to show an additional $6.3 billion loss on top of the $1.6 billion it first reported for the 2001 to 2004 period.

``They went through the wringer, they got new management, and they cleaned up their acts,'' said Zandi. ``What's happening now is they are feeling the same pressures that every other mortgage company has felt in the last year.''

The federal government can't afford to take over all of Fannie Mae's and Freddie Mac's operations, because such a move would more than double federal government debt outstanding and ``have disastrous consequences for the dollar,'' according to Joshua Rosner, an analyst with Graham Fisher & Co. Inc.

Instead, the government could move the companies' combined $1.5 trillion investment portfolio into a separate limited liability corporation that would gradually liquidate the assets, Rosner said.

Fannie Mae and Freddie Mac would still be able to support the U.S. housing market by packaging home loans into securities they guarantee.

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

Last Updated: July 11, 2008 17:35 EDT