Adding to investors' unease, Merrill Lynch might take a $15 billion hit from its exposure to soured subprime mortgage investments, according to The New York Times. The nation's largest brokerage is also said to be seeking another capital infusion to help shore up its balance sheet.
Investors also grew nervous after American Express Corp. warned late Thursday that slower spending and more delinquencies on credit card payments will hamper profit throughout 2008. A profit warning from Tiffany & Co. added to Wall Street's unease about the fortitude of the consumer.
Friday's session revealed the extent of investors' misgivings about the financial sector's efforts to sew up its troubles. Bank of America Corp. agreed Friday to buy Countrywide Financial Corp. for $4 billion, a deal that rescues the country's largest mortgage lender but pays less than the company's market value.
The agreement comes after word of the move Thursday and just months after BofA invested $2 billion in Countrywide. Some investors apparently hoped Countrywide would fetch a premium, though some observers said a tie-up was a better alternative for the beleaguered company.
Michael Church, portfolio manager at Church Capital Management in Philadelphia, said news from the financials is weighing on Wall Street, although he said few investors should be surprised that troubles in the sector remain.
"The financials are going to continue to be a problem," he said. "I think people are maybe still trying to get their bearings."
In the final hour of trading, the Dow fell more than 300 points, then regained a little ground in the normal ebb and flow of trading. It was down 272.23, or 2.12 percent, at 12,580.86.
Broader stock indicators also declined. The Standard & Poor's 500 index fell 20.69, or 1.46 percent, to 1,399.64, and the Nasdaq composite index fell 51.98, or 2.09 percent, to 2,436.54.
Stocks have skidded lower in the new year, with the Dow often falling by triple digits in a single session amid anxiety about a possible recession as well as the still-unfolding fallout from the mortgage crisis.
Bond prices rose as stocks retreated. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.80 percent from 3.88 percent late Thursday. The dollar was mixed against other major currencies, while gold prices rose to a fresh record.
Oil prices were pressured by gains for the dollar against the euro and pound. Crude oil is a dollar-denominated commodity and tends to decline in value when the dollar rises.This is because it takes less money to but the same amount. A barrel of light, sweet crude for February settled down $1.02 at $92.69 on the New York Mercantile Exchange.
Washington Mutual Inc. jumped 54 cents, or 3.8 percent, to $14.70 after CNBC reported JP Morgan is in talks to acquire the nation's largest savings and loan. JP Morgan fell 84 cents, or 2 percent, to $40.49.
Bank of America fell $1.03, or 2.6 percent, to $38.88, while Countrywide fell $1.12, or 14.4 percent, to $6.63.
American Express fell $5.62, or 11.5 percent, to $43.30 and was among the biggest decliner among the 30 stocks that comprise the Dow industrials. McDonald's Corp., also part of the Dow, fell $4.07, or 7 percent, to $54.10 after a Friedman Billings Ramsay analyst expressed doubt about the company's future earnings. He also said McDonald's stock is fully valued, indicating there may be little room for price gains.
Traders showed little reaction to a Commerce Department report that higher energy prices drove the nation's trade deficit in November to its highest level in more than a year. The government said the gap shot up 9.3 percent to $63.1 billion, the widest since September 2006 and up from $57.8 billion in October. Economists surveyed by Thomson/IFR Markets forecast a trade gap of $58.6 billion.
Separately, there was good news on inflation in December, when import prices were unchanged, the Labor Department said.
Federal Reserve Governor Frederic Mishkin said the Fed will act decisively to counter risks to the economy and added that swift rate cuts can hasten the economy's return to normal. But Mishkin also said the financial markets are overly focused on the central bank's actions.
Boston Fed President Eric Rosengren said housing price declines could accelerate this year if the economy is not strong. Mishkin and Rosengren follow Fed Chairman Ben Bernanke, who on Thursday made clear in a speech that the central bank is poised to cut interest rates later this month.
Declining issues outnumbered advancers by about 2 to 1 on the New York Stock Exchange, where volume came to 1.33 billion shares.
The Russell 2000 index of smaller companies fell 15.42, or 2.14 percent, to 704.79.
Overseas, Japan's Nikkei stock average closed down 1.93 percent. Britain's FTSE 100 closed down 0.33 percent, Germany's DAX index rose 0.06 percent, and France's CAC-40 fell 0.54.