Additionally, the U.S. rescue of American International Group failed to reassure investors, days after investment bank Lehman Brothers Holdings Inc filed for bankruptcy protection. The government agreed to rescue AIG via an emergency $85 billion loan.
Investors wondered who might be the next financial services company to come under strain due to the tight credit conditions. The S&P financial index fell 7 percent.
Shares of Morgan Stanley slumped nearly 25 percent to $21.61 on the New York Stock Exchange after CNBC television said the investment bank is considering whether it should remain independent or merge with a commercial bank. Shares of Goldman Sachs dropped more than 14 percent to $113.81 after several brokerages cut their profit outlooks for Goldman.
The Dow Jones industrial average .DJI shed 271.29 points, or 2.45 percent, to 10,787.73. The Standard & Poor's 500 Index .SPX declined 36.09 points, or 2.97 percent, to 1,177.50. The Nasdaq Composite Index .IXIC slid 69.62 points, or 3.15 percent, to 2,138.28.