Fannie/Freddie haircut would wipe out $372 billion in big bank capital

The big reason that Hank Paulson pushed a government takeover of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) is that he concluded, after Morgan Stanley (NYSE: MS) scrubbed their accounting, that the $84 billion in capital stated on their books was really worth $50 billion less. This made me wonder what would happen to the capital of other big banks if they took a similar 60% haircut.

The answer? Eight large U.S. investment banks would lose $372 billion worth of capital -- putting them all well below the minimum required capital ratios -- with an average ratio of equity to assets of 2.5% ($248 billion in capital to $9,788 billion worth of assets). My conclusion is that these banks lack capital to support their level of risk. So it should be no surprise they are reluctant to lend. The government and other sources of capital don't want to step in. And the challenge of recapitalizing them will be left for the next president.

Here are the four most vulnerable banks based on how low their ratio of equity to assets would be if they took a 60% capital haircut which marked their balance sheet more to market than to model:

• Morgan Stanley. Equity falls from $34 billion to $14 billion --> equity/assets from 3% to 1.3%
• Merrill Lynch (NYSE: MER). Equity falls from $35 billion to $14 billion --> equity/assets from 4% to 1.4%
• Lehman Brothers (NYSE: LEH). Equity falls from $26 billion to $10 billion --> equity/assets from 4% to 1.6%
• Goldman Sachs (NYSE: GS). Equity falls from $45 billion to $18 billion --> equity/assets from 4% to 1.7%