The problem isn't really that the characters are ugly, though yes, I agree that they are, for the most part, and it's not just by the standards the media would give us which are unrealistic for most people, even for an average person, I would not say someone who looked like http://images.uesp.net//e/ec/OB-npc-Jensine.jpg is pretty. But more than that, the faces DON'T feel realistic to me. It seems like they TRY to be realitic, but just end up looking
off instead. I think it's partially due to the weird skin tones that can come about with some characters (No human should have purple skin, if you see someone who does, SOMETHING IS WRONG WITH THAT PERSON) Also the lack of detail in the skin textures doesn't help, everyone looks like their skin is perfectly smooth and doesn't have any detail to it, but that's fixed by texture replacers. More than that, though, I think it's just that the characters don't seem to have realistic variety to their appearances, Sure, every character's appearance is somewhat different, but for the most part, no one has any really striking features. All the faces are just kind of... forgetable, sure, it's more realistic than everyone looking like a model, but the trade-off isn't that none of the characters really look memorable. I think the problem is primarily that this is Bethesda's first time using Facegen, while it brought a level of customization to player characters that was simply not possible in past Elder Scrolls games without using new face models, and helped to avoid the repeated use of the same face that plagued Morrowind, it also meant that none of the faces really stand out. Not that I'm saying Bethesda shouldn't use Facegen in future games, just that when using this kind of technology for the first time, the results might be ideal. But I think that with Fallout 3, they've already done better than in Oblivion, admitably, they did improve the quality of the facial textures somewhat, as well as adding actual beards to the game, but I like to think that having more experience working with Facegen also contributed to the improvement, and maybe there will be further improvements in future Bethesda games.
Though to be quite honest, if I can't have a realistic level of variety in the appearance of characters in my game, I'd rather have everyone look pretty than everyone look ugly. Either way is unrealistic, but at least if everyone is pretty, the characters are more pleasant to look at.
The bodies are kind of a problem too, but that's mostly because every character is stuck with the same body. So all characters, be they nobleman who never get any physical activity and have everything they need provided to them, powerful and skilled warriors, or beggers, all have the same generic, somewhat athletic but not extreme body, its even stranger when you have older characters as their faces might look like people in their sixties or seventies, but below the neck they look like people in their twenties. Unfortunately, as long as they game has only two body models, male and female, there isn't much that can be done to avoid that.
Well, tone can be adjusted, so that's not really much of an issue. There are some NPC's with strange skin though. Dion in Skingrad is an absolute Orange.
And he NPCs are the biggest problem, really, I can make my own characters look the way I want with enough effort. But NPCs look like they have some sort of disfiguring disease, the only thing I can do about that is download mods.