While the U.S. government’s plan to invest $250 billion into U.S. financial institutions has been billed as a strategy that will bolster the health of the banking system and also jump-start lending, the recapitalization plan is likely to have a secondary effect – one that whipsawed U.S. taxpayers likely won’t be very happy to learn about.

Those billions are a virtual lock to set off a merger tsunami in which the biggest banks use taxpayer money to get bigger – admittedly removing the smaller, weaker banks from the market, but ultimately also reducing the competition that benefited consumers and kept the explosion in banking fees from being far worse than it already is.

One last point: Experts say that takeovers financed by the government infusions are likely to have less of a beneficial impact on the economy than an actual increase in lending levels would have. And because so much of this money will be used for buyouts, the reduction in the benchmark Federal Funds target rate announced yesterday (Wednesday) by central bank policymakers will likely do very little to actually spur lending, experts say.

Fueled by this taxpayer-supplied capital, the wave of consolidation deals is “absolutely” going to accelerate, Louis Basenese, a mergers-and-acquisitions (M&A) expert and the editor of The Takeover Trader newsletter, told Money Morning.“When it comes to M&A, there’s always a pronounced ‘domino effect.’ Consolidation breeds more consolidation as industry leaders conclude they have to keep acquiring in order to remain competitive.”

Lining Up for Deal Money

Late last week, the Pittsburgh-based PNC Financial Services Group Inc. (PNC) became the first U.S. bank to make use of the government’s Troubled Assets Relief Program (TARP), announcing plans to purchase the beleaguered National City Corp. (NCC) for $5.2 billion. To help finance the purchase, PNC will sell $7.7 billion worth of preferred stock and warrants to the U.S. Treasury Department, as part of that department’s bank-recapitalization program.

With regards to that program, U.S. Treasury Secretary Henry M. “Hank” Paulson recently said – yet again – that the government’s goal was to restore the public’s confidence in the U.S. financial services sector – especially banks – so that private investors would be willing to advance money to banks and banks, in turn, would be willing to lend, The Wall Street Journal reported.

“Our purpose is to increase the confidence of our banks, so that they will deploy, not hoard, the capital,” Paulson said last week.

Whatever the Treasury Department’s actual intent, the reality is that banks are already sniffing out buyout targets, thanks to the TARP money. Indeed, they’ve been quite open about it during conference calls related to quarterly earnings, or in media interviews.

Take the Winston-Salem, N.C.-based BB&T Corp. (BBT). During a conference call that dealt with the bank’s third-quarter results, Chief Executive Officer John A. Allison IV said the Winston-Salem, N.C.-based bank “will probably participate” in the bailout program, accepting federal infusions. Allison didn’t say whether the federal money would induce BB&T to boost its lending. But he did say the bank would probably accept the money in order to finance its expansion plans,
The Wall Street Journal said.

“We think that there are going to be some acquisition opportunities – either now or in the near future – and this is a relatively inexpensive way to raise capital [to pay the buyout bill],” Allison said during the conference call.

Talk about brazen. However, he’s not alone. For instance, there’s also Zions Bancorporation (ZION), a Salt Lake City-based bank that’s feeling the pain due to losses from bad real-estate loans. On Tuesday, Zions announced it would be receiving $1.4 billion in capital from the Treasury Department – cash it would use to boost lending and keep paying a dividend, albeit at a reduced rate.

“As a strong regional bank with a major focus on financing small and middle-market businesses, we are pleased to have this additional capital to better serve the lending needs of customers throughout the Western United States,” Chairman and CEO Harris H. Simmons said. “We expect to deploy this new capital in the form of prudent lending in the markets we serve.