Financial Shares Hobble Markets

U.S. stocks tumbled Friday as downgrades on the two biggest home-funding companies dragged on the financial sector.

As the credit crunch drags on, Merrill Lynch has downgraded government-sponsored mortgage provider Freddie Mac to "sell."

Freddie shares were down more than 5 percent in early afternoon trading, while Fannie Mae stock had plunged more than 9 percent.

"It's good news that we're not tanking on Freddie and Fannie, like the market has done on other companies, but part of that has to do with the fact that everyone's so defensive already," said Steve Goldman, market strategist at Weeden & Co in Greenwich, Connecticut.

In addition, bond insurers MBIA and Ambac came under pressure as a downgrade in their ratings seemed more and more imminent. (Read more here).

An early rally on Thursday evaporated after the drop in the Philadelphia Federal Reserve bank's index of mid-Atlantic business activity and a separate index of national future economic activity signaled further trouble ahead.

Intuit ,a tax preparation software company, posted lower quarterly profit late on Thursday, sending its shares plummeting more than 12 percent.

Natural gas distributor Nicor gave an earnings outlook below analysts' estimates, citing continued demand weakness and operating cost pressure. Utility company PG&E is also set to report earnings on Friday.

Nicor shares were down almost 4 percent in afternoon trading.

With no economic data releases scheduled, investors will pay close attention to Dallas Federal Reserve President Richard Fisher when he speaks about the U.S. economic outlook in Fort Worth Texas at 1:30 pm New York time.

In other corporate news, Delta Air Lines and Northwest Airlines' faced further set backs in their plans to become the world’s biggest carrier, as Northwest may be forced to repay $245 million in outstanding debt on bonds that Minnesota's Metropolitan Airports Commission issued on its behalf.

Citigroup shares came under pressure after Meredith Whitney, executive director of CIBC World Markets, told CNBC the banking giant needed to cut its dividend, having been the first to say last year that Citigroup needed to reduce its payouts.

"As Citigroup becomes so challenged from an earnings perspective, its pay-out ratio will exceed 70 percent, and that is imprudent for a board to authorize," Whitney told "Closing Bell" Thursday.

The bank's shares were swapping hands about 3 percent lower.

In other news, the U.S. embassy in Belgrade, Serbia was set on fire last night as Serb rioters protested Kosovo's recent declaration of independence. The attacks were condemned by Washington, the UN Security Council and the Serbian foreign minister.

The European Union called on Serbia to protect foreign embassies if it wants closer ties with the bloc.

--Reuters contributed to this report.