By Chuck Mikolajczak
Analysts said if Greek voters reject the unpopular bailout, it would result in a "hard default" by Greece, causing bigger losses for banks and raising the threat of systemic risk.
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Greek Premier George Papandreou said he will put the nation's bailout deal through a referendum, potentially undoing last week's long-awaited agreement by EU leaders.
The news slammed European stocks, particularly the region's banks, which slumped 9.5 percent.
U.S. stocks briefly pared losses after the leaders of Germany and France said they were determined to fully implement decisions made at the European Union Summit last week.
"This was completely unanticipated ... It is not needed and it is just sort of an internal political thing," said John Canally investment strategist and economist for LPL Financial in Boston.
"This vote in Greece is going to hang over the market for next week or so, unfortunately."
The Dow Jones industrial average dropped 273.40 points, or 2.29 percent, to 11,681.61. The Standard & Poor's 500 Index lost 32.38 points, or 2.58 percent, to 1,220.92. The Nasdaq Composite Index tumbled 76.34 points, or 2.84 percent, to 2,608.07.
Stocks struggled to hold a key technical level surpassed after equities posted their best month in 20 years in October.
U.S. bank shares were lower, with the KBW bank index off 4 percent. Morgan Stanley tumbled 9.4 percent to $15.98.
Adding to the gloomy sentiment, factory activity in Asia's big export economies slowed to their weakest rate in nearly three years in October, while UK manufacturing suffered a sharp decline, reigniting fears of a global slowdown.
The S&P 500 traded below its 14-day moving average for the first time since October 7, pointing to a possible shift in short-term momentum. The benchmark also broke through strong support at 1,220 several times.
Economic data showed the pace of growth in the U.S. manufacturing sector slowed in October, in line with trends around the world, though improvement in new orders suggested resiliency in the sector.
In a move that put further pressure on commodity prices, Japan vowed to step into foreign exchange markets again to curb excessive speculation. The government sold a record $98.7 billion on Monday in yen to curb its strength, which is hurting Japan's export-based economy.
The U.S. dollar index rose 1.7 percent. U.S. oil futures dropped 3.6 percent, and copper prices fell 3.5 percent. Many commodities are priced in the greenback, making a spike in dollar prices more expensive for traders in other currencies and saps demand.
(Reporting by Chuck Mikolajczak; Editing by Kenneth Barry)