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The markets plummeted on Wednesday as Europe's debt crisis escalated to a new, more dangerous phase, taking Italy, one of the euro zone's biggest economies, as its latest victim.
The Dow Jones Industrial Average tumbled 389 points, or 3.2%, to 11,781, the S&P 500 slid 46.8 points, or 3.7%, to 1,229 and the Nasdaq Composite slumped 106 points, or 3.9%, to 2,622.
Wall Street has been fixated on developments from across the Atlantic for months as the euro zone's sovereign debt crisis has spread, posing an increased risk to the global financial system, and threatening to tip the region's economy back into a recession.
The selling was ferocious enough on the day to knock the broad S&P 500 and Nasdaq into the red for the year and significantly trim the Dow's gain. Volatility spiked 32%, while the yields on U.S. government debt tumbled as fears mounted. The benchmark 10-year Treasury note yields 1.969% from 2.084%.
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Every major sector was in the red, but financial stocks took the biggest beating by a wide margin. Indeed, Bank of America (BAC) and JPMorgan Chase (JPM) were the worst-performing blue chips, plunging more than 5% each.
Italy, with its public debt of roughly $2.6 trillion, or 120% of its total economic output, has become the latest focus. The yield on the country's debt has ballooned since the summer and the benchmark 10-year note hit a fresh euro-era high of 7.495% on Wednesday, according to an analysis by FOX Business, as traders have fled out of fear that the value of the debt will continue declining, and that the country may not be able to honor its commitments. Greece, Portugal and Ireland, much smaller economies with smaller absolute levels of debt, needed international bailouts when their debt yields topped 7%.
The problem for Italy is twofold. The higher the yield it needs to pay, the more expensive it becomes for the embattled nation to refinance its debt years down the line, increasing its overall debt level. Second, as yields climb and prices tumble, traders become more wary of purchasing the debt, and Italy could have trouble finding sufficient levels of lending on the private market, meaning it would need international support to refinance.
The country has begun putting in place economic reforms to cut back its debt level, but it isn't clear whether those reforms will be sufficient to cut down the debt, or convince the markets that it is on a sustainable path.
Italy's Prime Minister Silvio Berlusconi agreed to resign on Tuesday after a budget vote that is expected to be held next week, which market participants initially hoped would pave the way for reforms to pass through parliament, but the situation has become murkier. It isn't certain who will take over the country, and if that person, or group, will be able to get the reforms passed.
For Europe as a whole, Italy is particularly problematic because it is a such a major economy, so many banks hold its debt, and because its debt level is so high any potential bailout may be larger than the continent can handle on its own. Additionally, it has become much more difficult politically to pass rescue packages as countries like Germany have grown unwilling to spend to bailout other countries.
However, an Italian default, analysts say, could be catastrophic.
On top of the woes from Italy, the Greek situation is still not under control. The Mediterranean country's prime minister agreed to resign over the weekend, but also isn't clear who will fill the power vacuum there and assure financial markets that it will take measures to receive a much-needed bailout.
European blue chips tumbled 2.3%, Italian shares plunged more than 3% and the euro plummeted 1.8% to $1.359. The U.S. dollar, meanwhile, soared 1.1% against a basket of six world currencies.
Despite the heavy selling, some market participants saw the weakness as a buying opportunity.
"We're coming off of the highs," Larry Levin, founder of Trading Advantage told FOX Business in an interview. "Traders will step in and buy."
A bullish weekly inventory report from the Energy Department helped temper the losses in energy markets. The benchmark New York oil contract fell $1.06, or 1.1%, to $95.74 a barrel. Wholesale RBOB gasoline tumbled 6 cents, or 2.3%, to $2.64 a gallon.
In metals, gold fell $7.60, or 0.42%, to $1,792 a troy ounce.
The economic calendar is quite light on Wednesday, with a report on wholesale inventories being the only major release. Inventories were down 0.1% in September, smaller than the 0.1% increase in August, and the 0.5% jump economists had forecast.
General Motors (GM) posted quarterly results that beat Wall Street's expectations on the top and bottom line, but the American automaker pared back its European outlook, sending shares plunging.
Macy's (M) revealed third-quarter results that easily topped forecasts, but its glum view on the key holiday season spooked traders.
European blue chips tumbled 2.3%, the English FTSE 100 fell 1.9% to 5,460 and the German DAX slid 2.2% to 5,830.
In Asia, the Japanese Nikkei 225 jumped 1.25 to 8,755 and the Chinese Hang Seng rallied 1.7% to 20,014.