NEW YORK—Worries that the government may nationalize struggling mortgage finance giants Fannie Mae and Freddie Mac created yet another source of problems for beleaguered U.S. banks and brokers.
Fannie and Freddie, which purchase loans from banks and mortgage companies, together own or guarantee $5 trillion of debt, about half of all U.S. mortgages. These U.S. government-sponsored enterprises (GSEs) also loom large on the balance sheets of the country's financial institutions.
"GSE exposures create another area of likely write-downs," said Fox-Pitt, Kelton analyst David Trone.
Trone in a research note estimates that JPMorgan Chase's total exposure — holdings of GSE debt, mortgage-backed securities and counterparty risk — is $87 billion, or 69 percent of its equity.
Citigroup has exposure of $51 billion, or 40 percent, while Goldman Sachs has the largest total exposure among investment banks at $14.2 billion, or 32 percent of equity.
In addition, GSE bonds and mortgage securities generate underwriting and trading business that have fueled Wall Street profits for years.
Yet these important clients have been hard hit by the ongoing mortgage crisis. Worries about the survival of GSEs sent beaten-down brokerage shares lower on Friday.
Lehman, which is battling concerns about its financial health, saw its stock fall 17 percent. Goldman Sachs shares fell 5 percent.
Meanwhile, speculation that the U.S. government would take over the GSEs to protect debt holders — but likely wipe out equity investors — sent Fannie Mae shares down 21 percent and Freddie down 12 percent in late trade.
Treasury Secretary Hank Paulson on Friday threw cold water on the takeover speculation, saying the government wants to support the agencies "in their current form."
Separately, Reuters, citing sources, reported that Federal Reserve Chairman Bernanke considers the GSEs eligible to tap the Fed's discount window for funds. The Fed declined to comment.
"For the brokerage firms, that simply means that, yes, there is government support. It's not going away," Sanford C. Bernstein analyst Brad Hintz said.
Capital Weakness
Fannie Mae and Freddie Mac, though, face pressure to raise more capital amid a credit crunch that has generated about $400 billion of write-downs among banks worldwide.
Analysts estimate Freddie and Fannie need to raise as much as $70 billion of new capital to offset losses and fortify the balance sheet. The Wall Street Journal reported Goldman Sachs is advising Freddie on ways to raise capital.
Graham Fisher analyst Joshua Rosner in a note said nationalization of the two companies is unlikely because that would double the Federal deficit, weaken the dollar and raise Treasury's cost of funding. However, he said the GSEs are in trouble and regulators may choose other options, such as placing GSE assets into FDIC receivership.
"We do expect that GSE losses will rise to a level where they would need significantly more capital and, if they are unable to raise that capital from private investors, the government would have to step in to take action to protect the most senior 'guaranteed' obligations," Rosner said.
Yet some analysts and investors argued that the GSEs — particularly Freddie — have dug themselves a deep hole and need a bailout.
"Freddie is insolvent and Fannie is running on fumes. They're going to end up being nationalized," said Len Blum, a mortgage markets veteran and partner at investment bank Westwood Capital. "The entire financial web depends on them. If they failed, it would make Bear Stearns look like a picnic."
