Aside from bad mortgage-backs securities bets, a dying LBO business, auction rate securities, and deteriorating credit card debt, the banks and brokerages may be up against their largest challenge yet. They have to pay back or roll over hundreds of billions of dollars of debt between now and the end of the year.

Fannie Mae (FNM) and Freddie Mac (FRE) have to refinance $223 billion in paper by the end of September, but they are hardly alone. As money center banks and brokerages prepare to manage maturing debt during the second half, they will be faced with much higher interest rates. The credit crunch has done too much to drive the appetite for risk out of the market. Some of the larger financials could see their annual debt service rise by several billion dollars.

That is the beginning of the bad news, but it is not the end. The “floating-rate” notes banks used to borrow money in 2006 will come due this year and next. Credit was easy when that money was secured. Getting it replaced at any price may be difficult. According to The Wall Street Journal, “The problem highlights how the pain of the credit crunch, now entering its second year, won’t end soon for banks or the broader economy”

Where will that money come from? Since the capital markets may simply reject taking on so much new debt in troubled institutions, the Fed would seem like a good place to turn for the capital. That is the most likely thing to happen. Why pay 7% interest to re-finance when the Fed may do it for 3%?

The massive problem with finding a way to pay down bank borrowing could well be more significant than bailing banks out of their mortgage-backed securities. Many of those mortgage write-downs have come and gone. The process is not done, but a great deal of it has been worked through the system of Fed aid and lower rates designed to pull banks out of the swamp of the effects of a failing housing market.

The rolling over of “floating rate” debt has not hit the international financial system yet. Another rude shock to the complex operations of keeping a foundation under the global bank industry means that central banks will have to dig down deep to supply capital for a second tranche of rescues. The level of cash central banks will have to put into financial institutions will once again raise the question of whether banks are owned more by governments than by their sharedholers.

At some point, even the capacity of the central banks begins to falter. They rely on their governments to underwrite the stability of the system. That causes national debts to rise and traces its eventual funding back to the taxpayer. That is the same taxpayer who is having trouble paying his energy bill, mortgage, and credit card balance.

A new round of saving the banking system relies to a large extent on a troubled taxpayer base. The caissons of the system are rotten at their core.

Douglas A. McIntyre

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