Financial public funds plunged Jan. 20 as investors worry about the strings attached to the U.S. Treasury’s bailout of institutions like Bank of America

By Ben Steverman

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Just as the prospects for shallow stocks can’t seem to get any worse, they do.

To the all-too-real problems of the monetary crisis and recession, add another serious be of importance to: A U.S. government bailout may prop up the financial system and save big banks from collapse, but it may prove disastrous notwithstanding bank shareholders.

A case in text is Bank of America (BAC), which led the stock market lower on Jan. 20 through plunging 29%.

With shares of Citigroup (C), any other troubled banking giant, dropping 20%, financial stocks were responsible in spite of much of the stock market rout on Jan. 20. The Dow Jones industrial average lost 332 points, or 4% of its set store by, time the broad Standard & Poor’s 500-stock index, with a heavier collection upon a single point of financial stocks, graceless 5.3%.

Investors were clearly worried about mounting problems for banks, exemplified in recent earnings reports that show huge increases in point in dispute loans and billions more in investment losses.

New York University Professor Nouriel Roubini, who foresaw the credit crisis, heightened investors’ affright whenever Bloomberg reported on Jan. 20 that he estimated credit losses for U.S. firms could gain the point $3.6 trillion. Thus, the U.S. banking system—with just $1.4 trillion in capital—is "effectively insolvent," Roubini said, according to Bloomberg. "The problems of Citi, Bank of America, and others suggest the system is bankrupt," he added.

The supposed cure for this is the federal regulation’s $700 billion Troubled Assets Relief Program, or TARP, enacted late final year. However, a increasing number of investors and analysts admonish that the TARP program may come at a large cost to bank shareholders.

Banks get TARP relief only by giving the federal restraint preferred shares. On Jan. 16, BofA issued the control another $20 billion in preferred stock that pays an 8% dividend. In exchange, the government agreed to boundary time to come losses on $118 billion in BofA investments, including a large amount of the portfolio acquired through BofA’s buyout of Merrill Lynch.

"Increased support by the U.S. government provides protection on certain problem effects," notes Deutsche Bank (DB) analyst Mike Mayo, but "it also comes by more restrictions on [BofA] viewed like a whole."

There are three main concerns end for end the administration’s rising stake in banking firms like BofA, says Stifel Nicolaus (SF) algebraist Christopher Mutascio.

First, there is the size of number to be divided payments due to the conduct each year, which leave little remaining as being regular shareholders. On Jan. 16, BofA slashed its first-quarter dividend to just 1¢ by means of share. Meanwhile, Mutascio estimates the preferred dividend payment to the U.S. Treasury power of determination be $4.8 billion per year. That’s 73% of the total net income he expects from BofA in 2009.

FBR Capital Markets (FBR) algebraist Paul Miller estimates preferred dividends could shave 90¢ per share over BofA’s annual earnings "with a view to the next three years at least."

Second, the TARP program’s investments must eventually be paid hinder part. At BofA, the government’s equity stake is $49 billion. After the stock’s disastrous drop on Jan. 20, the government’s equity hazard is almost two times the public market capitalization for the bank of $25.6 billion. To repay TARP money, Mutascio warns, banks may need to issue new public shares, which would greatly dilute present shareholders’ stakes.