The Dow lost about 778 points and posted its biggest daily percentage decline since the October 1987 stock market crash, while the benchmark S&P 500 also had its worst day in 21 years after the House sent the bailout plan to defeat by a vote of 228 to 205.
The tech-heavy Nasdaq had its worst day since April 2000 when the Internet bubble collapsed.
The failure of the bill, which would have let the Treasury
buy up bad mortgage debt from struggling banks, added to serious concerns after the credit crisis claimed new victims, including Wachovia Corp and a bevy of European banks.
Fear was deep and widespread, as investors dumped stocks for the relative safety of U.S. government bonds. The Chicago Board Options Exchange Volatility Index, Wall Street’s main barometer of investor fear, jumped 39 percent to 48.40, a nearly six-year high, and was at 46.72 at the close.
"I am shocked. Credit markets were struggling even with the prospect this bill was going to get passed. Now the bill doesn’t get passed and it just throws one more monkey wrench into the mix," said Bob Doll, global chief investment officer of equities at BlackRock Inc, one of the world’s largest asset managers.
The Dow Jones industrial average sank 777.68 points, or 6.98 percent, to 10,365.45. The Standard & Poor’s 500 Index was down 106.59 points, or 8.79 percent, at 1,106.42. The Nasdaq Composite Index was down 199.61 points, or 9.14 percent, at 1,983.73.
An index of financial services shares lost 16percent, while Bank of America Corp fell 17.6 percent to $30.25.
Goldman Sachs slid 12.5 percent to $120.70.
"This is bad in a lot of different ways," said Bill Strazzullo, partner and chief market strategist at Bell Curve Trading, in Boston. "Short-term, the market is getting crushed, but more importantly, we are telling clients we could be at the beginning of a whole new down phase. There is the potential for the S&P 500 to go all the way down to 1,000."
The bailout’s demise comes after U.S. bank Wachovia was forced to sell most of its assets to Citigroup in a deal brokered by the Federal Deposit Insurance Corp.
That followed fast upon fresh signs that financial market turmoil was spreading around the world. European authorities in recent days were forced to step in and rescue a group of banks in Britain, Belgium, Germany and elsewhere.
Global money markets remained paralyzed, even as central banks, including the Federal Reserve, pumped cash into world markets in an attempt to boost liquidity.
Although there were doubts that the government’s rescue package would be sufficient to shelter the economy and stem the spread of the turmoil, investors said it was a necessary first step to restoring confidence in financial markets.
"We know that whatever they do won’t save all the ills from an economic perspective," said Kurt Brunner, portfolio manager at Swarthmore Group in Philadelphia. "But to sit and maintain this sort of limbo is not good, and financial markets are reflecting that."
Technology shares also took it on the chin with Apple Inc’s 18 percent slide to $105.26 leading the way after several brokerages slashed their recommendations on the tech bellwether and maker of the iPod.
Shares of Google fell 11.6 percent to $381, near a two-year low hit earlier in the day.
The bailout plan met heavy resistance from Republicans, who balked at the price tag and voted against the bill by a margin of more than 2 to 1. A majority of Democrats voted in favor.
"The problem is the American public resoundingly said ‘no,’" said Linda Duessel, market strategist at Federated Investors in Pittsburgh. "It’s such a difficult, complex and unprecedented situation, and maybe the average American either doesn’t understand it or accept the ramifications of what might happen if (Congress) doesn’t come through."
Volume was heavy on the New York Stock Exchange, where about 2.02 billion shares changed hands, above last year’s estimated daily average of roughly 1.90 billion. On Nasdaq, about 2.80 billion shares traded, well above last year’s daily average of 2.17 billion.
Declining stocks outnumbered advancing ones on the NYSE by about 30 to 1. On the Nasdaq, decliners beat advancers by more than 6 to 1.