NEW YORK – The banking crisis took an ugly turn for the worse Tuesday.
Shares of major banks plunged as investors feared that Washington's bailout efforts were stalling, potentially forcing President Barack Obama's newly installed government to take far more dramatic steps to prop up the U.S. financial system.
No major bank was spared the carnage. Bank of America's shares plunged 29 percent; Citigroup's 20 percent. State Street Corp., which reported sharply lower earnings, saw its shares plummet 59 percent.
At the core of the free fall in bank shares were concerns that U.S. officials would need to overhaul their program of shoring up financial institutions, a day after Britain announced its second financial bailout package for its own struggling banks in three months.
Investors are also becoming disheartened that banks such as State Street are continuing to report sharply worse results despite all the bailout efforts to date. The broader economic downturn is only compounding the pain by sapping demand for loans.
The country's economic problems were already high on Obama's priority list, but the breakdown of confidence in the country's banks, occurring on the same day of his inauguration, gave the matter fresh urgency. Attention will remain focused on the banking system on Wednesday as Obama's choice for Treasury Secretary, Timothy Geithner, begins Senate confirmation hearings.
"The honeymoon is already over for the new administration with the way these stocks were beaten down," said Edward Yardeni, an independent market analyst. "This is not a vote of confidence."
The market's faith in the outgoing Bush administration's $700 billion bailout effort was already waning, with critics in Congress and on Wall Street saying there was little to show so far despite the massive outlays of taxpayer money. The government had already veered from its original goal of buying up toxic assets from banks, choosing instead to make direct injections of capital into banks, with few strings attached.
"The fear is that the government will come first and shareholders will come last," Joe Battipaglia, market strategist for the private client group at Stifel, Nicolaus & Co. "It's a de facto nationalization because the government has run out of choices."
Many experts believe Obama's administration will have little choice but to pump more money into the banking sector or create an entity to buy banks' soured assets such as subprime mortgages so they'll start lending again.
Both moves would signal a dramatic increase in the government's involvement in the banking sector, possibly threatening shareholders whose holdings could be wiped out in the event of a government takeover.
Evidence that the banking crisis is worsening overseas also rattled investors. On Monday, the Royal Bank of Scotland forecast a loss of $41.3 billion in 2008, leading the British government to increase its stake in RBS to nearly 70 percent and launch a new round of bailouts for the country's banking industry.