Recession fears grew and investors raced for safe havens after U.S. lawmakers' shock rejection of a $700 billion rescue plan for the financial industry, with Asian stocks skidding after Wall Street's biggest fall since the crash of 1987.
Violent market reaction increased pressure on Washington to approve compromise bailout legislation and fuelled expectations that the Fed would cut interest rates on or before its next meeting, which is scheduled for Oct. 29.
"The markets are sending a clear message of the need for a U.S. government scheme of administration of its banking system soon — anything short of this is not an option," said Peter Pontikis, a strategist at Suncorp Medway in Sydney.
"Unwarranted delays will merely prolong the timeframe of an eventual U.S. recovery," he said.
A week that started badly with the rescue of three banks in Europe and the distressed sale of big U.S. lender Wachovia to Citigroup grew worse after the U.S. Congress was unable to agree on a rescue package.
Shares in Asia were down 3.4 percent in the afternoon, with Tokyo falling more than 4 percent. European stock markets were set to open between 2.5 and 4.4 percent lower after dropping 5.2 percent on Monday to a three-and-a-half year closing low.
Russia's stock exchanges suspended trading on Tuesday after the benchmark index lost more than 7 percent on Monday.
Uncertainty about what comes next, and whether the U.S. Congress can agree on legislation to relieve the worst financial crisis since the Great Depression sent investors into gold and U.S. Treasuries. Oil fell on fears of further economic slowdown, and the Japanese yen hit a 4-month high.
Investors worried that a collapse in financial markets would tip the United States economy into a painful recession that drags the rest of the world down with it.
"We do not rule out a U.S. recession being deep and long and having a severe global impact," said Gerard Lyons, chief economist at Standard Chartered in London.
However, Kansas City Federal Reserve Bank President Thomas Hoenig said that despite a sense that "the sky is falling", the U.S. economy is resilient and will emerge stronger from the current credit crisis.
"We need to take a deep breath and think about what is happening," he told a Kansas City Fed economic forum in Gering, Nebraska.
Fed funds futures showed the market saw a 76 percent chance of a 50 basis point rate cut by Oct. 29.
"With the financial storm as strong as ever and investors now looking to scramble and seek shelter, many see the Fed coming in and cutting rates to stimulate some confidence," Martin Batur, deputy head of dealing at IG Markets wrote in a note.
U.S. President George W. Bush was scheduled to make a statement on the rescue package at 1245 GMT on Tuesday after meeting on Monday with economic advisers including Federal Reserve Chairman Ben Bernanke to consider the administration's next move.
"I was disappointed in the vote that the United States Congress (had) on the economic rescue plan," Bush told reporters in Washington. "Our strategy is to continue to address this economic situation head-on and we'll be working to develop a strategy that will enable us to continue to move forward."
Both supporters and opponents complained about the way the administration presented the proposal as an urgent demand, accompanied by warnings of potential economic collapse, after years of sky-rocketing Wall Street bonuses, abusive mortgage lending, and regulatory neglect by the administration.
Global central banks scrambled to relieve a severe squeeze in money markets by more than doubling the amount of dollar funding to $620 billion as banks hoarded cash, bracing for more trouble ahead in the worsening credit crisis.
In moves to arrest market slides, regulators in South Korea and Taiwan clamped down on short selling, while Hong Kong said it was ready to take aggressive measures against abusive shorts.
EUROPEAN BANKS TOTTER
The shakeup in the financial landscape spread to Europe from the United States, with Belgian-French financial services group Dexia the latest to receive a bailout when three governments and key shareholders on Tuesday injected 6.4 billion euros ($9.18 billion) into the firm.
That followed government rescues of Belgian-Dutch group Fortis NV, Germany's Hypo Real Estate Holding AG, British mortgage lender Bradford & Bingley Plc and bailout deals in Iceland, Russia and Denmark.
U.S. regional banking heavyweight Wachovia agreed to sell most of its assets to Citigroup in a deal brokered by regulators.
"It just seems that there are only going to be two types of banks in existence now: the ones that survive and get market share or the ones that get gobbled up and have to be euthanized," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor in Cincinnati, Ohio.
MARKET MELTDOWN
The Dow Jones industrial average posted its largest point decline ever while the benchmark S&P 500 had its worst day since the 1987 crash with an 8.8 percent drop. Latin American stocks tumbled 13 percent, their biggest decline in more than a decade.
The House of Representatives voted 228-205 against a compromise bailout plan that would have allowed the Treasury Department to buy up toxic assets from struggling banks. House Republicans, in particular, balked at spending so much taxpayer money just before the Nov. 4 U.S. elections.
"I can't believe they weren't able to come together and come up with a solution. Complete disaster was predicted if it didn't pass," said Stephen Berte, senior equity trader at Standard Life in Boston. "I can't see what the upside is right now."
"We need a plan that works," said U.S. Treasury Secretary Henry Paulson, the Bush administration's point man on the bailout since the first plan was announced over a week ago. "We need it as soon as possible, and we're just committed to working with congressional leaders to get it done."
World stocks, as measured by the MSCI's world index lost about $1.7 trillion on Monday.
BAILOUT PROSPECTS UNCERTAIN
In Washington, the failure of the bailout bill after more than a week of high-pressure talks aimed at hammering out a compromise plan brought new uncertainty about the response of the U.S. government to the worst financial crisis in a generation.
Republican House members voted against the rescue package by a more than 2-to-1 margin. A majority of Democrats voted in favor. Both parties blamed each other for the failure of the closely watched bill after hours of closed-door negotiations.
U.S. presidential candidates Barack Obama and John McCain had both offered qualified support for the bailout proposal, which now dominates the election with just over a month before the vote.
Obama, a Democrat, said he believed lawmakers would regroup to pass a financial rescue plan. "I'm confident we're going to get there," he said as he campaigned in Colorado. "It's going to be a little rocky."
McCain, a Republican who suspended his campaign last week in a failed attempt to broker a bailout deal, called on lawmakers to go back to work. "Now is the time for all members of Congress to go back to the drawing board," he said.
The Senate returns on Wednesday and the House on Thursday after a break for the Jewish New Year holiday of Rosh Hashanah. No laws can be passed in their absence but their staffs could work on a revised plan.
