No one knows what housing market reform — especially the reshaping of the government-sponsored enterprises — will look like, but Wall Street certainly is paying close attention to its impact on a kee source of fee income.

That income comes in the form of activities such as underwriting debt for Fannie Mae and Freddie Mac, providing a market for their bonds and helping them hedge their massive holdings.

The GSEs do not conduct nearly as much business with Wall Street as they did before the financial crisis, when they were big buyers of private-label mortgage securities. Still, the agencies remain some of the Street's biggest clients.

Fannie and Freddie buy mortgages from banks, guarantee them and are involved with reselling the loans into securities.

At the end of 2009, they, along with the Government National Mortgage Association, guaranteed about $5.5 trillion. Fannie and Freddie also hold vast portfolios of mortgage debt, a combined $1.5 trillion at June 30, and they fund these holdings by issuing unsecured debt. Investment banks underwrite this unsecured debt and make a market in it, as well as in the mortgage-backed securities the GSEs issue.

Fannie and Freddie are also huge consumers of derivatives and U.S. Treasuries, which they use to hedge their mortgage bonds.

"Wall Street made a very large amount of money for a very long time on complex activity revolving around Fannie and Freddie," said Alex J. Pollock, a resident fellow at the American Enterprise Institute and former president and chief executive of the Federal Home Loan Bank of Chicago. "Like everything, MBS began life as a great innovation, and as time goes on, standardization or normalization turned it into a bread-and-butter business. But when you're dealing with $5 trillion of paper, including MBS and straight debt, and that paper churns all the time, and on top of that, [they have] huge hedging activity … it can't be ignored."

Underwriting GSE debt is a highly commoditized business, and it's easy to dismiss its value to investment banks' bottom lines.

Kenneth Posner, the author of "Stalking the Black Swan: Research and Decision-Making in a World of Extreme Volatility" and a former equity analyst who covered Fannie and Freddie for Morgan Stanley, said there is a perception that underwriting agency debt provides little more than an opportunity to manipulate a firm's standing in league tables.

"It's hard to believe anyone makes any real money," he said.

Yet agency debt accounts for a big chunk of all fixed-income underwriting. In the first seven months of this year, Fannie and Freddie, along with the Farm Credit banks and Federal Home Loan banks, issued a total of $853.4 billion of debt with a maturity of 18 months or more, according to Dealogic.

In the first half of this year, Fannie alone issued about $202.8 billion of long-term debt, according to its website.

Jim Vogel, an agency debt analyst at First Horizon National Corp.'s FTN Financial, said that while corporate debt underwriting "fell off the map in the second quarter," Fannie and Freddie issuance actually increased.

That's because as interest rates have fallen, the GSEs have been redeeming — and reissuing — a lot of the callable debt they use to hedge rate risk.

Kevin Villani, who was a senior vice president and chief economist at Freddie in the early 1980s, likens agency bonds to Treasury bonds, which also are issued in great quantity and trade heavily but have paper-thin spreads.

"Investment banks make a lot more money with new instruments and innovations, but they don't want to give up their bread and butter," he said.

Brad Hintz, an analyst at Sanford C. Bernstein, said that to a certain extent, doing business with Fannie and Freddie is no different from doing business with highly rated companies.

In both cases, he said, debt underwriting is a loss leader for investment banks; they take the work to land more profitable business with the same companies.

In dealing with Fannie and Freddie, Hintz said, banks make their real money helping the GSEs manage risk and selling them products. But Fannie and Freddie are no longer buying subprime mortgages to meet regulatory quotas for affordable loans, he said, and even though they still have a huge appetite for interest rate derivatives to hedge their holdings, new financial rules that will drive transactions onto regulated exchanges are going to make this business much less profitable for investment banks.

Even those who think Wall Street has a lot to lose from housing reform say banks might be better off without the GSEs.

"All commercial banks should be dead set against reincarnating Fannie and Freddie," Villani said. "Those are assets they should be funding, to the extent that they have deposits, and universal banks should be issuing covered bonds and maybe [private-label] MBS."

But he said banks do not want to be seen as opponents of GSEs, since that might come back to haunt them.

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