The data also showed that core wholesale inflation, which excludes often volatile food and energy prices, rose 0.7 percent - the biggest since November 2006 and more than triple the 0.2 percent rise in core prices that had been expected.
A weak report on new home construction also worried investors. The Commerce Department said July housing starts fell to an annual rate of 965,000 units, the lowest level in more than 17 years. The number was higher than the rate of 950,000 units analysts had predicted, but did little to quell investors' worries about the sector.
Tuesday's pair of economic reports indicated to investors not only that the financial sector is struggling to right itself after billions of dollars in credit losses, but also that the rest of the economy is still showing significant signs of stress.
The weakness in housing has not only imperiled home builders and suppliers, but has left financial companies reeling over how to cope with soured mortgage debt. Lehman Brothers Holdings Inc., for one, came under pressure Tuesday on reports that the investment bank might have to sell one of its businesses to raise cash.
One of the few bright spots, however, is the price of oil. Crude has fallen substantially from its July record above $147 a barrel, and fell 82 cents to $112.05 a barrel Tuesday on the New York Mercantile Exchange.
In early trading, the Dow Jones industrial average fell 79.38, or 0.69 percent, to 11,400.01.
Broader stock indicators also dropped. The Standard & Poor's 500 index fell 8.33, or 0.65 percent, to 1,270.27, and the Nasdaq composite index fell 14.71, or 0.61 percent, to 2,402.27.
Bond prices ticked higher after the economic reports. While investors often seek the shelter of government debt when bad news arrives, inflation is unwelcome for bonds because it devalues their fixed returns. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.80 percent from 3.82 percent late Monday.
The dollar was lower against most other major currencies, while gold prices fell.
Retailers reported mixed quarterly results, adding to investors' uncertainty about the economy.
Home Depot Inc. reported a 24 percent decline in its second-quarter earnings but topped Wall Street's expectations. The nation's largest home improvement retailer reiterated its forecast for the year amid a weak housing market.
Target Corp. said its second-quarter earnings fell 7.5 percent but topped Wall Street's expectations despite continued weak sales amid a challenging economy.
Saks Inc. is reporting a wider-than-expected loss in the second quarter as its affluent shoppers cut back on apparel amid a slowing economy. The luxury goods retailer also issued a downbeat forecast for the year.
Overseas, Japan's Nikkei stock average fell 2.28 percent. In afternoon trading, Britain's FTSE 100 fell 1.81 percent, Germany's DAX index lost 1.88 percent, and France's CAC-40 fell 1.98 percent.