U.S. bailout comes at steep price

NEW YORK Wed Oct 15, 2008 9:01am BST

The U.S. government plan to inject $250 billion (143 billion pounds) into the troubled banking industry will repair balance sheets and help restore market confidence, but the banks and investors will pay a hefty price. REUTERS/file

The U.S. government plan to inject $250 billion (143 billion pounds) into the troubled banking industry will repair balance sheets and help restore market confidence, but the banks and investors will pay a hefty price.

Credit: Reuters/file

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NEW YORK (Reuters) - The U.S. government plan to inject $250 billion (143 billion pounds) into the troubled banking industry will repair balance sheets and help restore market confidence, but the banks and investors will pay a hefty price.

U.S. officials announced on Tuesday a plan to inject capital by acquiring preferred stock and warrants to purchase significant stakes across a number of banks.

Half that amount will go to nine banks: Citigroup (C.N), JPMorgan Chase (JPM.N), Morgan Stanley (MS.N), Goldman Sachs Group (GS.N), Bank of America Corp (BAC.N) and Merrill Lynch & Co MER.N, Wells Fargo & Co (WFC.N), State Street Corp (STT.N) and Bank of New York Mellon (BK.N).

"I think it helps. It helps everyone who is participating," said Benjamin Wallace, a money manager at Grimes & Co. "These banks have to support others. They all have their share of exposures."

U.S. Treasury Secretary Hank Paulson, under pressure to restore order to the financial markets, pushed these top tier banks to participate so that there would be no stigma associated with the plan as it was rolled out throughout the industry.

Still the government's support, comes at a cost.

Fox-Pitt, Kelton analyst David Trone estimates that earnings per share for participating banks will be reduced by as much as 22 percent, at Wells Fargo, or as little as 6 percent, at Bank of New York.

Some bank executives, notably JPMorgan chief Jamie Dimon, contended they did not need the additional capital. JPMorgan, which recently raised funds for its acquisition of Washington Mutual, faces 11 percent dilution from the plan.

"Not everyone was on board, but Paulson realized you needed an industrywide solution," Grimes said.

CONFIDENCE

Certainly stock market investors applauded the plan, which will inject needed capital into some weak banks and help accelerate the end of the current credit crunch. Treasury also will back new bank debt, guarantee certain deposits and support commercial paper.

"These steps will have a significant positive impact on the crisis of confidence," Trone said.

Shares of Morgan Stanley surged another 21 percent Tuesday, after nearly doubling the day before, while Citi stock rose 18 percent as investors greeted news of even more capital strength. Goldman shares rose 11 percent.

Longer term, analysts said bank and broker stocks will "stall out" as investors shift their focus from survival to the business environment, which remains weak. That will yield rising losses from loans and problem assets as well as lower revenue.

Meanwhile, earnings now will be weighed down by the preferred dividends. For consumer banking giants Citi, BofA and JPMorgan, $25 billion of preferred stock will generate an annual expense of $1.25 billion.

JPMorgan shares fell 3 percent Tuesday amid worries the new capital was not needed and would drag on returns.

Goldman last month sold $5 billion of 10-percent preferred stock to Berkshire Hathaway (BRKa.N) and issued warrants to buy another $5 billion of stock. Goldman, which also issued $5 billion of common stock, will have to pay out a combined $1 billion each year to the government and to Warren Buffett.

Morgan Stanley on Monday completed a $9 billion sale of preferred stock -- yielding 10 percent -- to Mitsubishi UFJ Financial Group, a deal Morgan said gave it more than enough capital. Morgan's preferred dividend tab is an even steeper $1.4 billion a year

That said, some Wall Street observers say the stability that comes from the new capital outweighs any near term dilution or cutbacks in executive pay. Some weaker banks have little grounds to complain, said veteran Wall Street compensation consultant Alan Johnson.

"When you got begging, it's hard to complain if you get chicken instead of chateaubriand," Johnson said. "What can you say? If you don't like the terms, you can go broke."

(Editing by Tim Dobbyn)

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