(Updated with closing stock prices throughout)



) -- Financial stocks closed sharply lower on Monday, following the broader market on a bearish turn as investors lost confidence in a near-term economic revival.

The KBW Bank Index fell 4.5% at 43.76 while the Dow Jones Industrial Average dropped 2% to 9,135.34.

Charles Schwab

(SCHW) - Get Report

became the latest firm embroiled in the auction-rate securities mess. Schwab dropped 4.8% to $17.39 after New York Attorney General Andrew Cuomo filed a suit alleging that the firm had engaged in fraudulent sales and marketing of ARS.

"Charles Schwab owed its customers a duty to properly understand and make accurate representations," Cuomo said in a statement. "This filing should send a signal that anyone in the industry who misrepresented the risks of investing in auction rate securities will be held accountable."

Cuomo had announced an intent to file suit last month, so the charges were widely expected. Schwab says the allegations lack merit and that Cuomo ought to investigate underwriters rather than brokers. Competitors Fidelity and

Toronto Dominion's

(TD) - Get Report

TD Ameritrade already settled with Cuomo.

The online brokerages are not the only financial firms to be investigated or sued for practices related to ARS, which were often promoted as a "safe" alternative to cash. When the market for those securities dried up last year, customers were unable to retrieve funds for extended periods of time, causing an ARS liquidity crisis in the midst of a broader one.

Scores of other companies have reached settlements with the government or agreed to buy back the ARS from disgruntled clients. Among those that reached agreements are

Bank of America

(BAC) - Get Report

and its

Merrill Lynch


JP Morgan Chase

(JPM) - Get Report


Wells Fargo

(WFC) - Get Report



(C) - Get Report


Goldman Sachs

(GS) - Get Report


Morgan Stanley

(MS) - Get Report



(UBS) - Get Report


Credit Suisse

(CS) - Get Report

, National City, which is now owned by


(PNC) - Get Report

, and

M&T Bank

(MTB) - Get Report



(BBT) - Get Report

said Monday it will issue $750 million in new stock. The cash will go to fund its purchase of deposits and assets of

Colonial Bank

, which failed late last week. BB&T shares closed down 6.4% at $26.43.

Troubled commercial lender

CIT Group

(CIT) - Get Report

said Monday that it was able to repurchase nearly 60% of its $1 billion in outstanding debt at a 12.5% discount. The amount repurchased was less than the 65% CIT initially estimated, but the move was still significant because the buyback helps the firm avoid bankruptcy, though that route is not yet off the table.

CIT shares bucked the broader trend early in the day, but eventually closed down 3.6% at $1.36.

Elsewhere, Citigroup fell 4 cents at $4; Wells dropped 5.2% to $26.30; BofA gave up 4.8% to $16.56; and JPMorgan tumbled 4.1% to $40.73.

Also on Monday, the

Federal Reserve

announced that it would extend a program to add liquidity to the credit markets by another three to six months. The Term Asset-Backed Securities Loan Facility, or TALF, is now largely targeting commercial real-estate debt, whose market has dried up significantly as prices have plunged.

The $1 trillion program was extended to March 31 for old asset-backed securities that were issued before Jan. 1. The Fed will purchase newly issued ABS through June 30. Extending the program will help ease the woes of smaller banks whose exposure to CMBS has become a major concern. It will also grease the wheels of recovery so that lenders can make fresh loans for commercial deals.

It will also help

credit card

lenders that have been plagued by concerns about an impending wave of consumer defaults. It is unclear where banks stand in terms of credit card issues, because several lenders on Monday, including BofA, JPMorgan Chase, Citigroup and


(DFS) - Get Report

reported signs of improvement in defaults and charge-offs in July, similar to American Express' report weeks ago for June data. However,

Capital One

(COF) - Get Report

said defaults rose slightly.

Capital One shares dropped 2.9% to $34.06. Discover shares were down 2.8% to $12.13. AmEx fell 4.2% to $30.39.

-- Written by Lauren Tara LaCapra in New York