The downturn in stocks was first triggered by a report from Wal-Mart Stores Inc. that profit will fall below expectations this year as consumers rein in spending. Home Depot Inc., the world's biggest home improvement chain, added to the slide when it said weakness in the housing market caused quarterly profit to slide.

Confirmation that Sentinel Management Group Inc., which oversees $1.6 billion in assets, is seeking to halt investor redemptions exacerbated the selling. Other funds are said to have similar problems as they face withdrawal demands at a time it has become difficult to value low-quality debt.

Hedge funds and other big institutional investors have taken a beating in recent weeks due to the market turbulence. On Monday, Goldman Sachs Group Inc. said three funds it manages have had significant losses — and infused $3 billion in capital into one of them.

Wall Street has been pummeled as a deepening credit crunch spooked the market, and led to anxiety about potential losses at financial firms and funds. The Federal Reserve, which has injected some $64 billion of liquidity into the U.S. banking system since Thursday, said Tuesday it stood ready to act again should market conditions warrant.

While the market seemed to be looking past most economic news in recent weeks, on Tuesday the earnings reports and their implications for consumer spending compounded an already high state of anxiety on Wall Street.

"The market is very, very sensitive at this point, and any news about a potential financial problems is going to affect the way that the market trades," said Scott Fullman, director of investment strategy for I.A. Englander & Co. "We've been seeing extreme sensitivity in the financials, but also in the consumer stocks and industrials during the session."

According to preliminary calculations, the Dow fell 207.61, or 1.57 percent, to 13,028.92. The benchmark index is now on the verge of falling back below the psychologically-important 13,000 mark, which it first crossed in late April.