By flooding the U.S. banking system with hundreds of billions of dollars in cheap capital, the government could find itself funding the most dramatic change in the nation's financial landscape since the deregulation drive of the 1980s.
That's because the Treasury secretary and bank regulators will decide which banks get an infusion of government money, and which will be denied. Many of the nation's 8,400 banks -- especially the smaller and weaker among them -- may be allowed to fail or be swallowed by bigger rivals, industry analysts say.
"It will hasten consolidation, no doubt about it," said Frederick Cannon, chief equity strategist at investment bank Keefe, Bruyette & Woods Inc.
The stock market reflected that fact Tuesday, he said, noting that investors bid up the shares of banks more likely to be helped by the government, while shares of capital-starved institutions considered unlikely to get government funds declined.
The program is also likely to hasten the evolution of the country's financial system from a conglomeration of community banks into a network of bigger, interconnected institutions, said Timothy J. Yeager, a former economist for the Federal Reserve Bank of St. Louis and a finance professor at the University of Arkansas.
But not everyone agrees. Gerard S. Cassidy, managing director of bank equity research at RBC Capital Markets, said he believed the program would help some weaker banks stay in business, because they will be eligible for the same favorable terms the big banks will get for government capital.
"This plan by the Treasury blurs the lines between the haves and have-nots," Cassidy said. "The natural course of Darwinian banking has been interrupted by this plan."
The program's centerpiece is an infusion of $250 billion into the banking system through the government's purchase of nonvoting preferred shares in financial institutions.
As outlined Tuesday by Treasury Secretary Henry M. Paulson, Federal Reserve Chairman Ben S. Bernanke and Federal Deposit Insurance Corp. Chairwoman Sheila C. Bair, the banks will be required to pay dividends of 5% a year on the shares -- an attractively low rate for new capital -- rising to 9% after five years. The rate jump is designed to provide an incentive for banks to repay the taxpayers before the five-year mark.
The government will also take warrants for each bank it gives capital, which gives it the right to buy stock in the bank later. The device is aimed at giving taxpayers a chance to profit if the bank's stock rises during the period the bank is using the government's money.
Banks accepting the federal help will also face constraints on how much they can pay their top executives.
Although the three financial regulators tried to spell out the program in great detail Tuesday, much about it remains murky. One question is whether individual banking firms will find the government financing attractive.
Cannon contends that the government terms will be hard to resist.
"This is very inexpensive capital," he said. "Most boards will say it's very appealing, and I think we'll see a lot of participation."
Treasury officials tried to eliminate any stigma that might attach to the government assistance by announcing huge disbursements of capital to nine top financial firms Tuesday. Whether they succeeded in removing the stain is open to question.
"A lot of stronger banks will say, 'Thanks but no thanks -- why should I wear that scarlet letter?' " said Bert Ely, an independent bank consultant in Alexandria, Va.
Some bankers said that other elements of the Treasury's rescue plan, including an expansion of FDIC insurance to beyond $250,000 for non-interest-bearing accounts (those used mostly by business customers) might play a more important role in shoring up confidence in medium-sized and small banks.
"That will level the playing field," said Russell Goldsmith, chief executive of Beverly Hills-based City National Bank, the largest commercial bank in Los Angeles County.
Goldsmith said his management would "run some numbers" to decide whether it should apply for the government capital but said his institution was "well capitalized, and we haven't been looking for more capital."
There is little question that America's small banks are struggling to raise cash in a difficult environment, as bank consultant Jeff Rigsby of San Juan Capistrano can attest.
Many of the community banks Rigsby works with have been pressured by regulators over the last year to build up their capital, while others have wanted new funds to expand their business, he said. Both types of bank have struggled to sell new stock this year as investors have shied away from putting money into a banking business that has fallen under stress.
Stock offerings at existing banks with $3 billion or less in assets declined to 41 in the first half of this year, compared with 114 in the same period last year, according to a study by Rigsby's Community Bank Ventures.