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Editor's Note: The following piece was a collaboration with Minyanville professor Rob Roy.

"Dead Man Walking": Originally a phrase in a poem by Thomas Hardy in 1909, but later in a work of non-fiction by Sister Helen Prejean, A Roman catholic nun and one of the Sisters of Saint Joseph of Medaille. Prejean later wrote ‘Dead Man Walking’ which became a hit movie in 1995.

Death Row: A term that refers to the section of a prison that houses individuals awaiting execution. It is also used to refer the state of awaiting execution, even in places where a special section does not exist. As of 2008, there were 3,263 prisoners awaiting execution in the United States.

The Last Mile: "I guess sometimes the past just catches up to you, whether you want it to or not. Usually death row is called ‘The Last Mile’. We call ours The Green Mile’—the floor was the color of faded limes."
-Tom Hanks as Paul Edgecomb (The Green Mile)

Are there corporations that are "dead men walking"? When I first started in the industry in 1981 I was worried but about just one company, the Chrysler Corporation. Prior to that, Continental Illinois was in the forefront. Later in my career, in 1998, it was Long Term Capital Management, the hedge fund founded by John Meriwether, that captured my attention. Then we had Enron/WorldCom, and by early 2008 Bear Stearns became a worry and then a problem that needed fixing.

All of these events were isolated and dealt with, often with either direct assistance from Uncle Sam or an effort coordinated by America's benevolent/socialist government financial authorities. Markets would become unnerved, fear would grow, and then the government stepped in to make sure that the systemic risk that had finally come to the surface didn’t melt the entire planet.

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But this is where it's "different this time" - not only is it different, I think it may be unprecedented in nature. When I look at my Bloomberg monitor each day that contains my 100 most important indices, companies, commodities, bonds, bond spreads, preferred shares, etc., I shudder. The reason for my concern is that my screen doesn’t have just one "problem child." It looks like a screen that contains many "dead men walking."

The Failed Fannie Mae/Freddie Mac Experiment

I recently wrote a piece entitled A Tale of Two Markets, where I talked about the "Fannie Mae (FNM)/Freddie Mac (FRE) experiment." To me, that experiment has now clearly failed and a bailout/privatization/nationalization of Fannie and Freddie is probably being planned right now. While I have been expecting nationalization for quite a while, I am intrigued along with my peers and colleagues as to why the bailout is taking so long to accomplish. This is where, in my opinion, it gets interesting and dangerous from a systemic point of view. My hunch is that the reason for the delay is that the Treasury Department is "peeling back the onion" on Fannie/Freddie and finding out just how much of a mess the two of them are.

At last count, Freddie had Level 3 Assets of $151 billion while Fannie had $65 billion, for a not-so-paltry sum of $216 billion. When Freddie announced their results a couple of quarters back, it disclosed that most of its Level 3 Assets were of the "sub-prime" variety (the type of assets that started the whole credit crisis in the first place). The company's also littered with Alt-A mortgages and are leveraged to the hilt.

Just how bad is the news at Fannie/Freddie? On Friday morning, Moody’s downgraded their outstanding preferred stock 5 notches from A1 to Baa3 (a slight gradation above junk) and their Bank Financial Strength Ratings (BSFR) to D+ from B- (a one-half notch above D, which is reserved for companies in default). According to Moody’s:

"The downgrade of the BFSR reflects Moody’s view that Fannie Mae and Freddie Mac’s financial flexibility to manage potential volatility in its mortgage risk exposures is constricted ... in particular, given recent market movement, Moody’s believes these companies currently have limited access to common and preferred equity capital at economically attractive terms."

Dead men walking defined. Moody’s went on to say:

"The GSEs' more limited financial flexibility also restricts their ability to pursue their public mission of providing liquidity, stability and affordability to the US housing market. Fannie Mae and Freddie Mac currently make up approximately 75% of the mortgage market in the US. A reduction in the capacity of these companies to support the US mortgage market could have significant repercussions for the US economy. In an effort to thwart broader economic effects, Moody’s believes the likelihood of direct support from the United States Treasury has increased."

"We the People" are about to become owners in Fannie and Freddie, whether we like it or not. The capital markets have shut on them both as their stocks trade in the $2-5 range, down from the $70-80 level just a year ago. And the yield on the outstanding preferred shares hovers in the 18-23% range: Quite the bargain if they keep paying, but also it's the market’s way of saying "Beware the value trap" as the preferred shares may pay another dividend or two, but that's about it.

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