When the Treasury peels back the onion, I believe they will find a hornet’s nest. So I think we will see an initial bailout of $100 billion or so, with 2/3rds to 3/4ths going to Fannie as it's a larger organization. The scenario I foresee, however, (just as has happened at Merrill Lynch (MER), Lehman Brothers (LEH) and Morgan Stanley (MS)), is that they came to the financing window expecting to have borrowed enough, and then they have to keep coming back repeatedly until the buyers go away, until "We The People" have thrown at least $500 billion at Fannie/Freddie to get them back on their feet again. This will also likely take an Act of Congress to raise the Treasury’s Debt ceiling quite dramatically.

Who might be the other "dead men walking"?

More Dead Men Walking: Is There a Pattern?

What strikes me the most about impaired companies, whether they are automakers, airline companies, banks, brokers or GSE’s is that they seem to sing the same tune, that there is a pattern of behavior. This is how I have attempted to identify in the past what would be in trouble in the future (whether that was just to avoid their stocks and bonds from the long side or to try to profit from their missteps on the short side).

It's a pattern that isn't terribly dissimilar from the emotion charts I like to focus on so much. But in the graphic below, I will run this analysis on banks. I call this cycle the “Dead Man Walking Cycle.”

The first "tip-off" or "tell" is when a company releases earnings or some sort of positive announcement and the stock falls. Another important tell is the credit spreads of the debt of the company begins to widen. Then, the company will usually announce that "all is well and is so great that we will buy back stock and not cut the common dividend." After this comes the "acceptance" phase and write-offs/write-downs are announced and that some sovereign wealth fund or private equity firm will inject capital or that a company within the same group will buy a "strategic stake." After a brief pop in the stock and short covering rally, the stock begins to fall further and credit spreads begin to blow out and preferred shares get hammered. Then, more write-downs and more write-offs and another capital raise and finally a dividend cut to "preserve capital."

Sound familiar yet? All of this goes on for quite some time, until your stock price is so low that you would have to issue so many shares in a secondary offering that you dilute your shareholder base until it is unrecognizable. With this new share offering your credit, while still rated investment grade, trading like junk, your preferred shares rise to double digit yields. Further, the former strategic buyers, sovereign wealth funds and private equity firms, have taken such a beating that there are no further buyers. Yet the write-downs and write-offs continue unmercifully as the economy slows and credit is all but cut off. Eventually, dividends go to zero and you are a "dead man walking."

There are only a few things that can happen to the companies that are walking "The Green Mile." Either you make it to the electric chair (in The Green Mile it was called "Old Sparky") and cease to exist or you are eventually forced into the arms of a better capitalized institution. Over time, I expect a bit of both but mostly of the latter.

Keep in mind that if too many are allowed into the arms of "Old Sparky," it will have a systemic effect as all the institutions are so intertwined, because when one group of institutions are forced to mark their bonds to market, others are forced to do the same, ending in an ugly daisy chain. I think the chain has formed and that many are about to "walk the Mile."

In the end, perhaps years from now, I feel it's likely that many banks and brokers will be merged into an international list of "good banks" or "Live Men Walking." Who are these "Live Men Walking"?

They will likely be Bank of America (BAC), Bank of New York (BK), JP Morgan Chase (JPM), Northern Trust (NTRS), State Street (STT), US Bancorp (USB), ABN Amro , Deutsche Bank (DB), BNP Paribas, Royal Bank of Scotland, Barclays (BCS), Allianz (AZM) and a few others.

Here's an illustration of the cycle in which a good bank might fall into the "Dead Man Walking" category. 

Who Are the Dead Men Walking?

In the cycle above, it begins with denial, and ultimately ends up in despair. At first, the company denounces that anything is wrong, but Mr. Market has a way of sniffing out who is imitating Pinocchio. Ultimately, they company ends up in "despair" when they need or want to raise capital to just be able to function normally, but alas, they can't because the window of opportunity to raise capital has shut.

Let’s use Lehman Brothers as the poster child of this sort of behavior. I wrote a piece last week that singled out National City (NCC), Washington Mutual (WM) and Lehman Brothers as three problem children. Before the credit crisis started, Lehman, at the time known for its savvy timing, suddenly came to market for $5 billion of long-term bonds when it didn’t need capital, or did they know something was awry, as I suspect? Last year, with the credit crisis in its infancy, Lehman announced a $100,000,000 stock buyback. The shares, as you would expect, popped on the news, but no stock was ever re-purchased. As the stock began to sell off, the company kept saying that capital was not needed.

Then, on June 9, 2008, it sold 143,000,000 shares at $28 per share. As the hedge fund manager David Einhorn said, "They've raised billions of dollars they said they didn't need to replace losses they said they didn't have." In between was an enormous preferred stock deal: 75,900,000 shares at $25 per share at a rate of 7.95%. Those shares now change hands at $15 per share for a yield of 13.1%. It's pretty hard to turn a profit when your cost of capital is greater than 10%.

During this time, the company actually raised its common dividend by 15% year-over-year back in January. They have written off north of $8 billion since the credit crisis began and when they release earnings (or lack thereof) next month, estimates are for another round of $2-4 billion of write-downs. They have reportdely been trying to shop $40 billion of impaired real estate and they are mired in all sorts of Alt A, sub-prime, CMBS and CDO’s and CLO’s.