Markets lose more than 3% on Italy debt worry

Worries over political turmoil in Italy and the country's rising borrowing costs put the U.S. markets into a slide that meant a loss of more than 3 percent for each.

The yield on the benchmark Italian government bond spiked above 7 percent, a sign that investors are losing faith in the country's ability to repay its debt. Analysts say Italy will not be able to refinance its debt at current rates, which will force it to either enact deep austerity measures or to receive financial assistance to prevent a default.

Early reports blamed the bond spike on uncertainty over the country's future as Prime Minister Silvio Berlusconi steps down, but Bloomberg News reported President Giorgio Napolitano said there's no uncertainty over Berlusconi's pledge to resign and Italy will approve austerity legislation "within a few days." Napolitano also said a new government can be formed quickly, according to an emailed statement today from Rome. There's no risk of "prolonged political instability," he said.

Greece, Portugal and Ireland required bailouts when their bond yields rose above 7 percent. But unlike those countries, Italy's $2.6 trillion in debt is too large for other European nations to bail out.

The Dow closed down 389.2 points, or 3.2 percent, at 11,780.9. At one point it was down 407.8 points. The Standard & Poors 500 index closed off 46.8 points, or 3.7 percent, at 1,229.1. The Nasdaq composite closed down 105.8 points, or 3.9 percent, to 2,621.7.

Europe's debt crisis continued in Greece as well. The country's two main political parties are still engaged in power-sharing negotiations and have yet to name a prime minister to lead the interim government. The new government must pass an austerity package to receive the next loan installment of emergency loans. Without the funds, Greece could default before Christmas.

Markets fear that a chaotic default by either Greece or Italy would lead to huge losses for European banks. That, in turn, could cause a global lending freeze that might escalate into another credit crisis similar to the one in 2008 after Lehman Brothers fell.