Banks Plagued by Capital Woes

Updated from 3:02 p.m. EST

Financial stocks were deep in the red Tuesday, as investors fretted about banks' continued capital woes and contemplated a new administration's impact on the U.S. government's approach to the problem.

The Keefe Bruyette & Woods bank index, which tracks the nation's 24 largest banks, fell 20% to 25.34 on Tuesday, amid a steady stream of bad news. The U.K. on Monday announced a second rescue plan for the country's pained banks, raising concerns that the government might have to further nationalize some British financial institutions.

Britain's pain comes as President Barack Obama's administration goes about the work of doling out the second half of a $700 billion U.S. bailout approved by Congress in October. Congress last week authorized the release of the second $350 billion in Troubled Asset Relief Program funds, which the new administration will decide how to use. Options include increasing preferred equity stakes in banks taken in the fall, the approach taken by the Bush administration, or buying bad assets weighing down their balance sheets, TARP's original intention.

Both the U.S. and the U.K. governments are trying to "ring fence problem assets" by either setting up "bad banks" or, in the U.K.'s case, "an insurance scheme that will underwrite bad assets for a fee," UBS analysts write in an industry note on Monday.

"On a systemic basis, we view the latest government initiative to ring-fence bad assets as a step in the right direction, potentially moving the sector closer to balance sheet stability," the note said. "A critical question is whether banks have enough capital to take the losses on the bad assets or whether more capital will be needed before the cleaning up process can begin."