The prospects of a government "bad" bank to handle toxic assets finally taking shape drove up bank stocks in after-hours trading on Tuesday.

The news came on a day when the markets were up for the second day in a row. The

Dow Jones Industrial Average

jumped 57.70, or 0.72%, to 8,174.73, while the

S&P 500

rose 9.14, or 1.09%, to 845.71. The

Nasdaq

added 15.44, or 1.04%, to 1,504.90.

Image placeholder title

Dylan Ratigan, the moderator of

CNBC

's "Fast Money" TV show, asked Steve Liesman, CNBC senior economics reporter, to comment on reports that Obama administration is closing in on a plan to purchase bad bank assets.

Liesman said some industry lobbyists were meeting with the Treasury Department to discuss the "bad bank" alternative. He said the bank could handle as much as $1 trillion in bad bank assets, and that the plan could be announced as early as next week.

Liesman said his sources say the key issue in the talks is the pricing mechanism. He noted two keys to understanding of how the mechanism would work: The government would hold on to the toxic assets to maturity, and it has cheap funding that will allow it to pay more for the assets than their book worth.

In some cases, he explained, the government will offer less than the carrying costs, with the bank issuing common equity to make up for the difference. He said the plan would do away with the previous use of preferred stock.

Liesman said the important thing to remember is that the government doesn't want to put taxpayers in a position of overpaying for the assets in the effort to remove the bad assets from the banks' books.

Karen Finerman said she was concerned about how the government would price the assets. Joe Terranova said the news should cause a pop in bank stocks, but advised investors "not to be married" to these positions.

Ratigan also reminded Liesman that the bailout plan is not going to solve the public confidence problem until the executive compensation clawback issue is also dealt with.

Bill Siedman, former chairman of the FDIC, offered a tougher approach to handling the toxic assets. He alluded to his own experience during the S&L crisis when the Resolution Trust Corp., in effect, nationalized the banks for a short time to take out their bad assets before shifting them back to the private sector.

Terranova endorsed the idea of an "ultimate liquidator," saying that's the approach that should be adopted now.

Ratigan shifted the discussion to some of the major market movers today. Seymour said the financial stocks were a big boost. "It looks like we are starting to some movement from the beaten-down names," he said.

Yahoo!

(YHOO)

shares were up in after-hours trading. Pete Najarian said Yahoo's numbers were better than expected. Carol Bartz, the new CEO of the company, also said everything was on the table, with respect to Yahoo's future.

Bristol-Myer

(BMI) - Get Report

shares were also up. Najarian said the company is impressive not only because it had better-than-expected earnings but because it has $8 billion in cash and "another $1.5 billion added to it" for acquisitions.

Ratigan asked Seymour to comment on today's decline in oil prices. Seymour said the oil markets will be weak in the first quarter but insisted it's "a great place to buy it."

Terranova disputed a Goldman Sachs report that the short trade on oil is still on. He said he would play it "back and forth," and not go "aggressively short."

Seymour said he was encouraged by the upbeat earnings from

US Steel

(X) - Get Report

. He also said he's excited about the trading prospects in iron ore and coal.

Najarian said he liked

Northfolk Southern

(NSC) - Get Report

because it beat its numbers and raised its dividend. "They're cheap now," he said.

Ratigan asked the panel to comment on the companies at the forefront of the digital revolution. Najarian said he loved

Palm

(PALM)

and

Nokia

(NOK) - Get Report

.

He also expects

Juniper Networks

(JNPR) - Get Report

and

Cisco

(CSCO) - Get Report

to benefit from the build-out for the 3-G network.

Terranova marveled at the rise in

Research in Motion

(RIMM)

, which is up 34% since the beginning of the year.

Anthony Diclemente, an analyst with Barclays Capital, said companies like

Google

(GOOG) - Get Report

,

Apple

(AAPL) - Get Report

and

Netflix

(NFLX) - Get Report

are all benefiting from the big shift to the digital video delivery system that allows consumers to access content such as TV shows and movies via streaming and downloading.

That shift, he said, is making it much tougher for content providers.

Ratigan asked Zachary Karabell to comment on the water infrastructure play. He said the development of the global infrastructure to deliver potable water is one of the few areas where the "industrial expend is immune."

He said a great way to play that is with

Claymore Global Water ETF

(CGW) - Get Report

.

In the final trades, Terranova was for

Dryships

(DRYS) - Get Report

. Seymour said to sell Yahoo! Finerman said to pick up

ProShares UltraShort Lehman 20+ yr. ETF

(TBT) - Get Report

on a pullback. Najarian said to reduce exposure in Yahoo!

"Check out

"'Fast Money'Portfolios of the Week" on Stockpickr every Thursday.