The major averages all suffered daily losses of about 2%.

The market is gripped by "subprime contagion," said Peter Boockvar, equity strategist at Miller Tabak. "These are the same problems that have been weighing on the market for the last couple of weeks," he said, referring to the downtrend seen ever since the Dow fell 415 points exactly two weeks ago.

The market's downturn accelerated in the early afternoon after news that the number of homeowners unable to meet mortgage payments and entering the foreclosure process hit a record high in the fourth quarter. See full story.

"The subprime issue is a little more contagious than people thought and it is spreading some fear in the market," said Jay Susskind, director of trading at Ryan Beck & Co.

The Dow Jones Industrial Average closed down 242.66 points at 12,075.96, its worst fall since its massive February 27 selloff, with 29 of its 30 were in negative territory..

Among financial stocks -- American Express Co. and Citigroup Inc. took losses over 3% and JP Morgan Chase & Co. gave up 4.4%.

With the implosion of the U.S. subprime mortgage market and global concerns about financial liquidity, "there has been a real change of sentiment for financials and that's a sign the market is getting more risk adverse," Hyman said.

General Motors Corp. fell 2.6% after its financing unit GMAC said earnings were significantly hurt by the company's Residential Capital LLC, or ResCap, unit amid the decline in the housing market and rising subprime issues.

The S&P 500 fell 28.65 points to 1,377.95, while the Nasdaq Composite lost 51.72 points to 2,350.57.

Technology shares were also weighed by a downbeat outlook from Texas Instruments, whose shares fell 2.6%. And Google fell 2.6% after news that Viacom has filed a $1 billion lawsuit alleging that its unit YouTube used more than 160,000 of its videos without permission.

Trading volume was 1.96 billion shares exchanging hands on the New York Stock Exchange and 2.194 billion shares trading on the Nasdaq stock market. Declining issues outpaced gainers by 27 to 4 on the NYSE and by 5 to 1 on the Nasdaq stock market.