Bank of America, Citigroup Drag Bank Stocks Lower in Market Rout

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Banking stocks, with Bank of America (BAC) and Citigroup (C) out in front, are leading the charge lower in Thursday's stock-market bloodbath.

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Obviously, its their exposure to the banks in Europe, said Peter Cardillo, head market analyst at Rockwell Global Capital. The reason why were seeing the banking sector under pressure is the new fears of a European situation. In a nutshell, its the fear factor over the European debt crisis.

Shares of Bank of America were down 49 cents, or 6.5%, to $6.97 in morning trading, while Citigroups stock was down $2.35, or nearly 8%, to $27.50, having fallen more than 10% earlier in the session.

Bank of Americas stock has been battered for weeks on concerns the banking giant may be forced to repurchase billions of dollars of bad mortgages approved in the years leading up to the collapse of the U.S. housing market.

The stock is off more than 50% this year, including a 20% plunge on Aug. 8 alone. Recently, analysts have raised concerns that Bank of America, the largest U.S. lender by assets, might have to sell additional shares in order to comply with new international requirements on capital levels targeting banks deemed too big to fail.

The recent resurgence of Europes debt woes has only made matters worse. Both Bank of America and Citigroup, like all big U.S. banks, have broad exposure to the largest European financial institutions.

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On Thursday The Wall Street Journal reported that federal and state regulators in the U.S. are taking an increasingly harder look at European banks U.S. operations in an effort to stave off another financial crisis.

The fear, according to the report, is that the collapse of one or more of the big European banks could have a similar impact as the collapse of investment banking giant Lehman Brothers nearly three years ago.

The Wall Street Journal said officials at the Federal Reserve Bank of New York  "are very concerned that European banks may have difficulty maintaining their cash-flow levels, which they use for day-to-day operations and to make loans and repay their own loans. If that were to occur, it could be the start of a credit market seizure similar to the one that began in the fall of 2008.

In a worst case scenario, given Bank of America and Citigroups already precarious situation, the concern is that they could be early dominoes to fall in a potentially global ripple effect.

On top of those industry-specific concerns was a deluge of terrible economic news: Morgan Stanley (MS) issued a report saying the global economy is likely headed into another recession; the number of people who applied for unemployment in the U.S. rose higher than anticipated last week, adding more gloom to stagnant U.S. labor market; inflationary concerns rose on a report that consumers are paying more for gas, food and clothes; and a regional report on factory activity in the Philadelphia area was appalling. Indeed, a report from Barclays noted that it's rare for the Philly Fed index to fall so dramatically -- it came in at a reading of -30 -- for the U.S. not to be in a recession.