NEW YORK - Worries that an Italian financial collapse could crack the eurozone sent markets tumbling Wednesday, with losses topping three percent in US trade.
A selloff of Italian government bonds sent the yields to new highs above 7.4 percent, a level seen unsustainable for the finances of the European Union's fourth largest economy.
Even though Prime Minister Silvio Berlusconi pledged to resign and leave politics when the country is firmly committed to a credible reform plan, markets saw the future as still unclear.
Portugal, Ireland and Greece, all much smaller economies, were forced to seek bailouts when their debt hit yields at that level, and some analysts questioned whether the 17 member eurozone could handle such a large rescue like Italy.
Along with the still-unsettled politics of Greece -- the original epicenter of the crisis -- the turmoil sent the euro sinking by more than two US cents to $1.3544 at around 2200 GMT, from $1.3773 a day earlier.
Traders pushed into US dollars and US bonds, while shunning any risk.
"The Italian bond market is in distress," said Kathleen Brooks, an analyst at traders Forex.com.
"Although Berlusconi promised to resign after the passage of austerity reforms gets through parliament, the bond market may be reacting to the potential for a fractious coalition government getting into power, which could only exacerbate Italy's fiscal situation," she added.
"It seems investors are now questioning the debt-strapped country's political and financial trajectory -- and, more importantly, what that could mean for the euro zone," said Andrea Kramer of Schaeffer's Investment Research.
The US markets sank immediately on opening and fell through the day, with the Dow Jones Industrial Average closing down 3.20 percent to 11,780.94.
The broad-based S&P 500 lost 3.67 percent to 1,229.10, while the tech-heavy Nasdaq Composite dropped 3.88 percent to 2,621.65.
The major European markets fared somewhat better, in fact.
In London, the FTSE-100 gave up 1.92 percent at 5,460.38 points; Paris's CAC-40 lost 2.17 percent to 3,075.16 and Frankfurt's DAX 30 dropped 2.21 percent to 5,829.54.
Milan though fell 3.78 percent and Madrid, 2.09 percent.
Some analysts said the crisis could be at the tipping point, with Italy too big to bail out given the size of its economy, accounting for 20 percent of the eurozone bloc's output.
Berlusconi's decision "has done nothing to help stem the spiraling rise of Italian bond yields, leading some commentators to suggest that on paper the country is now past the point of being able to (be saved)," said Yusuf Heusen at IG Index in London.
Currency investors fled to safety. The yen gained, with the euro buying 105.38 yen compared to 107.50. The euro dropped to 1.2316 Swiss francs from 1.2382 Tuesday.
Gold fell to $1,774 an ounce from $1,795.
US bond prices jumped as well as buyers fled eurozone paper. The yield on the 10-year Treasury dropped to 1.96 percent from 2.07 percent Tuesday.
Meanwhile the spread on the rate of return between benchmark French and German 10-year bonds rose to a record 1.47 percentage points, up from just 0.45 percentage points a year ago.