The Dow Jones industrials fell 348 points to the 10,482 level, according to preliminary calculations.
Investors are also discouraged after news from the government of declining factory orders and a seven-year high in jobless claims.
There's no need to explain to Al Lubrano how deeply tight credit has wounded the economy.
Lubrano, president of a metal components maker in Lincoln, R.I., said orders from his customers in the automotive, computer, and telecommunications industries have "dropped precipitously" in the past six weeks.
"I'm going to have to lay people off," he said, if the economy doesn't improve.
He's not alone. The government reported Thursday that factory orders took the biggest drop in two years in August as businesses cut back on purchases of large equipment and consumers spent less on autos, electronics, appliances and other goods.
When manufacturing takes a hit, jobs get pummeled. More people than expected lined up at the unemployment lines last week, according to government data released Thursday, pushing claims for jobless benefits to a seven-year high.
There's more pain to come, predicted Lubrano, if the House doesn't pass a $700 billion plan to buy bad assets from banks and other institutions to shore up the financial industry and eventually thaw frozen lending.
Lubrano met with President Bush Thursday as part of a group of business representatives who favor the package approved by the Senate Wednesday night.
"You're going to see jobless rates shoot up like you haven't seen in years" if the package doesn't pass, said Lubrano. His company, Technical Materials Inc., has about 200 employees and is already planning to reduce its workers' hours over the holidays.
The weak economy, and the impact of Hurricanes Ike and Gustav, caused new claims for unemployment benefits to increase slightly last week to 497,000, the Labor Department said Thursday.
That's the highest since claims reached 517,000 roughly two weeks after the Sept. 11, 2001 terrorist attacks, the department said. It's the second-highest since 1992, according to David Resler, chief economist at Nomura Securities.
The hurricanes, which hit Texas and Louisiana earlier this month, added about 45,000 claims from the two states, the department said.
The hurricanes have led to higher claims for several weeks. As a result, the four-week average of claims, which smooths out fluctuations, jumped to 474,000, up 11,500 from the previous week.
The number of people continuing to receive benefits increased to 3.59 million, up 48,000 and higher than analysts' estimates. That's the highest total in five years.
Jobless claims are at elevated levels even excluding the hurricanes. Weekly claims have now topped 400,000 for 11 straight weeks, a level economists consider a sign of recession. A year ago, claims stood at 324,000.
The figures are likely to get worse, analysts said, because they don't yet include thousands of potential layoffs likely to result from the turmoil on Wall Street.
Just this month, investment bank Lehman Brothers filed for bankruptcy protection, while Merrill Lynch & Co. Inc. was bought by Bank of America Corp. Citigroup Inc. purchased Wachovia Corp. and JPMorgan Chase & Co. scooped up Washington Mutual.
The negative economic reports could also add pressure on the Federal Reserve to cut its benchmark interest rate in an effort to bolster the economy. Many economists think the Fed could even move before its next meeting Oct. 28.
Credit markets, meanwhile, remained locked up as banks are wary of lending to each other, unsure of which might be the next to collapse.
The London Interbank Offered Rate, or LIBOR, for 3-month dollar loans rose to 4.21 percent Thursday from 4.15 percent the day before. The LIBOR is the rate many banks charge each other for overnight loans and is used as a benchmark for trillions of dollars of auto, student and other consumer loans.
Martin Regalia, chief economist for the U.S. Chamber of Commerce, said the higher short-term rates for banks make credit harder to get for everyone else.
"When you build a dam upstream, you don't get any water downstream," he said.
