Stocks dropped on both sides of the Atlantic as Italy's borrowing costs soared, intensifying concern that efforts to contain the European Union's debt crisis aren't working.
Yields on Italian bonds soared to the highest level since the introduction of the euro, sending 10-year debt yields above 7 per cent, putting the euro-zone's third-largest economy into the danger zone.
US companies are feeling the pinch. General Motors shared plunged more than 7 per cent after the car maker dropped its target for European results, citing "deteriorating economic conditions."
In afternoon trading in New York, the Dow Jones Industrial Average shed 1.76 per cent, the Standard & Poor's 500 Index fell 2.06 per cent and the Nasdaq Composite Index dropped 2.24 per cent.
"It's just like a scary movie as it never ends," Keith Wirtz, chief investment officer at Fifth Third Asset Management in Cincinnati, told Bloomberg News.
"The overarching problem is that most of the economies in Europe can't sustain the size of their governments. We're going to have this headache for a long time to come."
In Europe, the Stoxx 600 Index ended the day with a 1.7 per cent drop. The index had risen as much as 1 per cent earlier in the session a day after Italy's Prime Minister Silvio Berlusconi said he would resign.
But that optimism faded quickly.
"We just added another layer of uncertainty. The issue with Italy brings the region closer to a broader negative scenario and raises more concerns about a financial crisis," Bob Pavlik, chief market strategist at Banyan Partners in New York, told Reuters.
As Italy's bond yields reached levels that required Ireland and Portugal to seek help from the European Union and the International Monetary Fund, the European Central Bank stepped in to buy Italian bonds.
"The ECB is buying aggressively," one trader told Reuters.
Meanwhile, LCH.Clearnet raised the margin the clearing house demands on Italian debt, making it more expensive to hold the beleaguered nation's bonds.
German Chancellor Angela Merkel told a conference in Berlin that Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she said, Reuters reported.
Some expect next year will be another tough one for equity investors.
US and European equities will climb "modestly" by the end of 2012 amid uncertainty over global economic growth and Europe's sovereign-debt crisis, according to ING Investment Management, Bloomberg reported.
Investors can expect benchmark indexes to finish unchanged "at best" in 2011, ING's senior equity strategist Patrick Moonen told Bloomberg. "Our base-case scenario is about 5 to 6 per cent growth for equities next year. 2012 will not be a smooth ride," he said.