Banks surge on $250B investment plan
Investors cheered government capital injection plan but some experts remain wary it will work.
NEW YORK (CNNMoney.com) -- U.S. officials returned some confidence to the badly shaken financial sector Tuesday with a sweeping plan to inject capital directly into banks.
In their boldest plan to date to get credit flowing again, Treasury Secretary Henry Paulson, joined by Federal Reserve Chairman Ben Bernanke and FDIC Chairman Sheila Bair, said the U.S. planned to invest up to $250 billion in ailing financial institutions.
Investors cheered the news as shares across the banking sector soared, including eight of the nine of the nation's leading financial institutions that signed up for the plan after reportedly meeting with regulators Monday afternoon in Washington. These banks collectively will receive $125 billion.
Included in that group were commercial banking giants Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500), each of which would get an investment worth $25 billion from the Treasury Department, according to two individuals familiar with the matter.
The money to Bank of America also includes a government investment in Merrill Lynch, which Bank of America agreed to buy last month.
Shares of Citigroup, Bank of America, Wells Fargo and Merrill Lynch all soared more than 10% Tuesday. Shares of JPMorgan Chase fell 3% though.
One money manager said that JPMorgan Chase's stock may have fallen due to concerns about the company's third-quarter earnings, which will be released Wednesday morning.
Although the bank has largely weathered the credit crisis, it is expected to report a loss due mainly to its late-September acquisition of failed savings and loan Washington Mutual.
"It seems to be an anomaly," said Frank Barkocy, director of research with Mendon Capital Advisors, a firm that invests primarily in financial stocks.
Wall Street giants Goldman Sachs (GS, Fortune 500), Morgan Stanley (MS, Fortune 500) both participated in the deal and will each receive $10 billion, sources said. State Street (STT, Fortune 500) and Bank of New York Mellon (BK, Fortune 500), two firms which primarily focus on processing bank transactions and wealth management services instead of the traditional retail banking business, will receive $2 billion and $3 billion respectively.
Shares of all four firms finished sharply higher during Tuesday trading.
Separately, the Treasury Department also disclosed Tuesday that it hired Bank of New York Mellon to act as financial custodian and supervise many of the aspects of the government's $700 billion bank bailout plan.
Industry experts believed that the steps announced Tuesday, combined with previously outlined plans by the Treasury to acquire troubled assets from banks, should go a long way towards putting the embattled U.S. banking sector back on track.
"These programs will mitigate further erosion of the economy," Daniel Alpert, managing director of Westwood Capital, a New York-based investment bank, wrote in a research note published Tuesday.
Citigroup banking analysts Keith Horowitz and Greg Ketron called the capital plan "a game changer," and upgraded 12 banks to a "buy" rating as a result of the announcement, including regional banks KeyCorp (KEY, Fortune 500) (KEY, Fortune 500) and BB&T (BBT, Fortune 500).
Fellow Citigroup analyst Prashant Bhatia, who tracks Morgan Stanley and Goldman Sachs, upped his rating of the two former stand-alone investment banks as well, saying that the investment from the government would make it easier to access the credit markets so they can raise more capital.
But even as some industry experts praised the capital injection plan, calling it just what the U.S. economy needed, others remained unconvinced.
There is the risk, for example, that some banks may not want to participate.
"While the capital program is available to all banks, given that 95 percent of our banks are well capitalized, we would not expect most banks to participate," Edward Yingling, the president and CEO of the American Bankers Association said in a statement Tuesday.
Banks that have done an effective job of riding out the current market turmoil so far may not see the value in selling stakes to the government, noted Bernard Horn Jr., president and portfolio manager at the Boston-based Polaris Capital Management, which operates the Polaris Global Value Fund.
"The majority of medium-sized institutions are still reasonably healthy," said Horn, whose firm manages about $3 billion. "For them, this isn't as big of a deal."
At the same time, capital has not remained out of reach for banks -- despite the turmoil in the market.
Morgan Stanley, for example, sold a 21% stake of itself to Japanese bank Mitsubishi UFJ Monday for $9 billion. And Bank of America managed to complete a stock sale last week, although the price of the offering was below expectations.
As of late, banks have been hoarding capital not only to insure their own survival, but partly due to fears that their lending partners may not be able to repay the loan.
Experts have maintained that the capital injection plan would go to the heart of that problem and that by providing capital to banks would foster lending not only among financial institutions but also improve access to credit for both consumers and businesses.
Some experts have estimated that every dollar of capital injected could result in roughly $10 of credit available to borrow.
But instead of lending money back out, some banks could use the cash to plug holes in their balance sheets, noted Barkocy.
"There is always a risk that the funds will not get in the right hands in the sense that banks might try to husband some capital rather than putting it out," said Barkocy.
Certainly, action by European governments in recent days to take stakes in their banks prompted U.S. officials in making the unpopular choice of considering ownership in these troubled institutions.
Instead of letting the system cleanse itself by letting troubled firms fail, banks that faced a grim future prior to Tuesday may be able to live on for another day.
"The problem with the government plan is it doesn't cleanse the gene pool," said Horn. "We don't have that sense of urgency if the government comes in and supports everything." 
