Stocks tumbled 3 percent on Wednesday in the market's worst day since mid-August as a spike in Italian bond yields signaled the European debt crisis had worsened.
All 10 S&P sectors were down, but S&P financials were the hardest hit on worries about European exposure, dropping 5.4 percent.
U.S. stock markets have grown more chaotic in response to rising volatility in European debt markets, and investors have trouble keeping up with a steady stream of headlines and pricing in how the crisis might play out.
The market has turned into a derivative of what's happening in Europe, said Craig Hodges, president at Hodges Capital Management in Dallas, Texas.
The Dow Jones industrial average was down 389.24 points, or 3.20 percent, at 11,780.94. The Standard & Poor's 500 Index was down 46.82 points, or 3.67 percent, at 1,229.10. The Nasdaq Composite Index was down 105.84 points, or 3.88 percent, at 2,621.65.
Dominating market moves are day traders and people trying to capture and skim decimals off stocks, Hodges said.
The spread of the crisis to Italy has lifted it to a new level. European Union sources said German and French officials were discussing drastic plans, including an overhaul that would possibly create a smaller euro zone.
Italy's bond yields shot up to 7.502 percent, a new high since the euro was introduced in 1999. Investors were forced to sell Italian bonds after a European clearing house increased the collateral needed to borrow against that debt.
The 7 percent level was the point where European nations, including Ireland and Portugal, had to seek bailouts as their financing costs ballooned.
General Motors Co slid 10.9 percent to $22.31 after the automaker said it would not break even for the year in Europe, as it had forecast, due to deteriorating conditions in the region.
The S&P 500 saw its worst daily percentage drop since August 18.
Prime Minister Silvio Berlusconi's insistence on elections instead of an interim government raised concerns of prolonged instability and delays to economic reform.
Italy has replaced Greece at the center of the euro zone debt crisis and is seen teetering on the cusp of requiring a bailout. A deal on forming a Greek national unity government collapsed while economic turmoil continued.
Reflecting growing market anxiety, the CBOE Volatility Index VIX jumped more than 30 percent, its biggest daily percentage gain since mid-August. The index usually moves inversely to the S&P 500 as traders use it as a hedge against falling stocks.
Italian bonds are essentially serving as another fear index like the VIX, and right now they're reflecting a lot of fear, said Charles Reinhard, deputy chief investment officer at Morgan Stanley Smith Barney in New York.
Among bank stocks, Morgan Stanley fell 9 percent to $15.76. Goldman Sachs Group Inc dropped 8.2 percent to $99.67. Bank of America Corp lost 5.7 percent to $6.16.
(Reporting by Caroline Valetkevitch, additional reporting by Ryan Vlastelica; Editing by Kenneth Barry)