"It's pandemonium. Everyone thought it was going to pass," said Adam Fazio, currency strategist at CIBC World Markets in New York.

Toronto's S&P/TSX composite index closed down 841 points, or 6.93%, to 11285, the Dow Jones industrial average closed down 778 points, or 6.98%, to 10365, the S&P 500 closed down 106 points, or 8.81%, to 1107 and the Nasdaq closed down 200 points, or 9.14%, to 1984.

Leaders of both U.S. parties believed they had enough support to pass the bill. As the votes were electronically cast at the U.S. House of Representatives, the early tally showed those in favour with the lead. But the 'nay' votes soon began to gain momentum. As it became clear the vote would fail, equities plunged.

It was the largest decline in the S&P 500 since Oct. 19, 1987. Of the 500 companies that make up the index, only one closed higher -- Campbell soup.

"The street got ahead of itself thinking that the bailout package was [a] done deal," said Francis Campeau, equities strategist from MF Global. "I think we are going to see some margin calls tomorrow and we could see another drop."

Market watchers are hopeful the deal can be altered and resurrected. Barney Frank, the Democratic chairman of the House Financial Services Committee, said no single element of the bill was responsible for its failure. He said his party will assess the economic reaction of the failure before moving forward.

"It is unclear at this point whether the legislation can be resuscitated," said Brian Bethune, chief U.S. financial economist from Global Insight.

Market watchers have turned to central banks for relief. Interest rate derivatives have spiked higher, indicating a growing belief that central banks may lower interest rates.

The December Euribor contract was up 19.0 ticks to 95.040. The OIS market is pricing in a 40-50% chance the European Central Bank will lower rates on Thursday.

The December BAX contract climbed 29 ticks to 97.19 and the December Eurodollar contract climbed 3 ticks to 96.730.

"A coordinated central bank rate reduction of 50 basis points, or more - by the Fed, the Bank of England, the Bank of Canada and the Reserve Bank of Australia - is certainly not off the table given the scale of the crisis," Bethune said.

Earlier on Monday, 10 global central banks announced coordinated efforts to improve market liquidity. In addition, the Federal Reserve increased the size of the 84-day TAF auction to $75 billion, and announced two "forward TAF" auctions worth $150 billion each to be conducted in November.

U.S. two-year yields were down 38.4 bps to 1.71%, with five-year yields down 33.2 bps to 2.72%, 10-year yields down 23.5 bps to 3.62% and 30-year yields down 21.7 bps to 4.15%. The Eurodollar March 09 contract was up 24.5 ticks to 97.31. The yield curve was steeper, with the 10/2-year spread up 8.7 bps to 190.38 bps.

Yields on two-year Canadian government bonds were down 28.4 bps to 2.54%, with five-year yields down 23.6 bps to 2.90%, 10-year yields down 17.1 bps to 3.51% and 30-year yields down 11.4 bps to 4.02%. The December 08 BAX contract was up 15.0 ticks to 97.05.

In Germany, returns on two-year German bonds were down 22.6 bps to 3.44%, with five-year yields down 21.5 bps to 3.69%, 10-year yields down 19.2 bps to 3.97% and 30-year yields down 14.4 bps to 4.58%.

Yields on UK two-year bonds were down 24.1 bps to 4.01%, with five-year yields down 21.7 bps to 4.17%, 10-year yields down 16.3 bps to 4.38% and 30-year yields down 7.4 bps to 4.46%.

The U.S. dollar opened the week higher after a series of bank bailouts and nationalizations is Europe. Along with the Japanese yen and Swiss franc, the U.S. dollar later benefited from safe haven flows.

The U.S. dollar weakened shortly after the bill was defeated, but came out of the meltdown in equity markets relatively unscathed. George Androulidakis, director of FX trading at National Bank, said he's expecting the U.S. dollar to weaken significantly in the next few days as investors lose confidence in the country.

"This is not good news for the U.S. dollar. The politicians are playing chicken with investors stuck in the middle. That will do nothing to instill confidence in the markets," he said.

The Canadian dollar was down 0.0095 to 0.9587 against the U.S. dollar (1.0431 USD/CAD) and down 2.83 to 99.77 against the yen.

The U.S. dollar was down 1.94 to 104.08 against the yen and the Dollar Index was up 0.631 to 77.584.

The euro was down 0.0167 to 1.4447 against the U.S. dollar, down 0.0035 to 1.5070 against the Canadian dollar, up 0.0065 to 0.7988 against the pound sterling and was lower by 4.53 to 150.39 against the yen.

The pound sterling was down 0.0362 to 1.8084 against the U.S. dollar and down 0.0215 to 1.8863 against the Canadian dollar.

WTI crude oil was down $11.38 to $95.51. The front month gold contract at the Chicago Board of Trade was up $23.20 to $912.50 per ounce.

All data taken at 4:18 p.m. EDT.

By Adam Button, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Sarah Sussman, This email address is being protected from spam bots, you need Javascript enabled to view it

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