If you are looking for the root of all problems that currently ail us, look no further than the banking sector.  This crucial piece of the capitalistic machine in the United States faltered under the weight of an unprecedented boom in the housing space.

Providing loans to fuel growth, banks were able to make huge amounts of money.  With Wall Street behind it offering to buy whatever loans could be underwritten, a drunken orgy ensued.

We are now living with the hangover, and unfortunately this hangover will not be cured with a few aspirin.  Instead, we have the largest government bailout in history.  $700 billion is the current number, but nobody really knows if this amount is enough.

While it is positive that the government took action, it is a bit worrisome that they moved so quickly.  The original intent of the rescue package was to provide liquidity to the mortgage backed securities market.

The government would hold auctions to buy these toxic securities, thereby setting prices in a market that is currently frozen.  The theory is that once a price is set, other buyers would step in and confidence in lending would return.

Certainly a good idea, but the plan is already being changed.  With European governments taking the lead, Treasury began exploring the idea of using a portion of the bailout package to make investment into banks directly.

That means Treasury will be essentially deciding what banks will be the winners and what banks will be the losers in the current environment. (See also: "Winners and Losers of the Bailout.")

Everyone expects a period of consolidation in the banking sector, but will the new plans by the government have unintended consequences?  Could we end up with a small few banks that dominate the industry?

That looks to be the consequence of cleaning up this mess.

Earlier last week Treasury announced that it would be taking $250 billion and buying preferred stock of banks around the country.  Half of the money would be used to take positions in nine very large institutions with the rest being deployed across the banking spectrum.

The nine chosen ones include Goldman Sachs (GS), Wells Fargo (WFC), Citigroup (C) and JPMorgan (JPM).  The names of the other banks receiving capital are unknown. (See also: "Is Citigroup Strong Enough to Survive?")

It is pretty apparent what is happening here.  There will indeed be mass consolidation in the industry.  The most likely scenario is that mid-tier banks will be absorbed by the chosen nine leaving the small community banks in their wake.

There will then be a banking system with a few very, very large players and a large number of smaller banks with nothing in the middle.  Whether that is a good thing or not is debatable.  What is important for investors is understanding the new dynamic. (See also: "Nationalization of Banking System Continues.")

We know who the winners will be, thus investing in these nine large banks is a wise long-term investment strategy.  The risk for losses is essentially eliminated by government protection.  More importantly, such protection comes without diluting common shareholders.

It is not entirely risk-free play as common investors could still be wiped out should these banks require even greater infusions of capital, but it is pretty close.

As for the mid-level banks, I would advise treading cautiously.  This will be the most dangerous piece of the banking puzzle. We do not know which mid-size banks will fail and which banks will survive.

We do know that the larger banks with government capital will make an effort to acquire more deposits.  The only question is at what price.  Will they wait for failure, thus a bargain basement price, or will they preempt bankruptcy bidding prices higher in an attempt to get an edge on the competition?

The mid-level space is too uncertain in my opinion.

That leaves the smaller community banks.  Here there is a much better understanding of the loans that were given and few risks taken with respect to leverage and no document loans.  As such there can be greater confidence in these banks lending as they have in the past.

Some of the smaller banks pay handsome dividends and most are now trading at or near 52 week lows.  Three possible names in the space include TierOne Corp. (TONE), Frontier Bank (FTBK) and Macatawa Bank Corp. (MCBC). (See also: "How to Keep Your Money Out of Harm’s Way.")

Dividends on each are 3.7%, 2.9%, and 9.6% respectively.  The size of these dividends indicates the amount of perceived risk in the space.  I think investors can exploit these prices and do so with the knowledge that the government will be there if needed.

The banking space may seem like a very scary place these days, but that is when money can be made.  With government intervention, a floor has been placed on the entire group.  It may take years for all of this to fully unwind, but long term investors should come out ahead in the end.

This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com.