NEW YORK (MarketWatch) -- U.S. stocks were slammed hard again on Wednesday, with the Dow Jones Industrial Average skidding to its lowest close since late 2005, as tightening credit conditions intensified fears about further failures in the financial sector.

"The policy response to the crisis in capital markets continues to take form, with reports that policymakers are now entertaining the creation of an RTC-[Resolution Trust Corp.] like entity," said Michelle Meyer, an analyst at Lehman Brothers Research.

Shares of Morgan Stanley MS, -2.35% and Goldman Sachs GS, -1.14% suffered their biggest one-day losses ever, falling 27% and 19%, respectively, as federal regulators rushed to tighten rules against short-selling before another major Wall Street securities firm faces collapse. Gold futures leaped $70 an ounce to $850.50, their biggest one-day price jump in decades.

“ 'Credit is seizing up as we speak.' ”

“ Kevin Giddis, Morgan Keegan & Co. ”

Down more than 800 points, or 7%, so far this week, The Dow Jones Industrial Average DJIA, -0.47% dropped 449.36 points, or 4.1%, to finish at 10,609.66, its lowest closing level since Nov. 9, 2005.

All 30 of the blue-chip indexes' components finished in the red, with American International Group Inc. AIG, -1.23% down the most, losing 45.3% to finish at $2.05 a share.

A spokesperson for Dow Jones Indexes declined comment on whether the index provider might remove AIG from the blue-chip index. Dow Jones Indexes was monitoring the situation, the company said in a statement late Tuesday.

The S&P 500 SPX, -0.48% declined 57.2 points, or 4.7%, to 1,156.39, with financials leading sector losses among the index's 10 industry groups, off 9.2%.

The Nasdaq Composite COMP, -0.29% dropped 109.05 points, or 4.9%, to end at 2,098.85, its first triple-digit decline since the first day of trading after the terrorist attacks of September 2001.

Virtualization software company VMware Inc. VMW, +1.92% was among the tech stocks hit, its shares down 10.6% as analysts expressed concerns about its business. See more.

Volume topped 2.1 billion shares on the New York Stock Exchange, and for every stock on the rise, 15 declined. On the Nasdaq, more than 1.3 billion shares exchanged hands, and decliners led advancers 5 to 1.

Choosing Money Markets Smartly

New rules

In a bid to protect investors from so-called "naked" short selling of securities, the Securities and Exchange Commission is requiring short sellers and their broker dealers to deliver securities by the close of business on the settlement date, starting Thursday. See full report.

“ 'It would seem that the government's role in the private sector is experiencing a Renaissance.' ” — Action Economics

"It would seem that the government's role in the private sector is experiencing a Renaissance following its bailouts in the finance and insurance sectors," said analysts at Action Economics.

Also weighing on equities, the Commerce Department estimated its count of new building permits for single-family homes fell to a 26-year low. See Economic Report.

The federal takeover of AIG triggered massive safe-haven buying of gold, with gold futures climbing $70 to end at $850.50 an ounce on the New York Mercantile Exchange. Read Metals Stocks.

"Nobody wants to own a 'paper' asset," said Amaury Conti, an equity trader at investment advisor Austin Calvert-Flavin. See Commodities Corner.

Elsewhere on Nymex, crude-oil futures climbed $6.01 to finish at $97.16 a barrel. See Futures Movers.

The government's takeover of AIG, made through an $85 billion loan, came late Tuesday after regulators acknowledged the company's failure would create havoc in the world's financial system. Read full story.

Experts say the bailout gives AIG some time to sell businesses such as its aircraft-leasing unit. See more.

"The Fed is trying to provide liquidity as quickly as it can, but there seems to be an endless supply of 'moles' and only one mallet," said Kevin Giddis, managing director, Morgan Keegan & Co. Inc. "Credit is seizing as we speak. The banks aren't really lending to each other."

Barclays said it would pay $1.75 billion to buy the U.S. investment banking and capital markets operations of Lehman Brothers Holdings Inc. LEH, , with the deal needing approval of U.S. bankruptcy courts. See details.

Shares of Morgan Stanley MS, -2.35% continued their recent slide, losing 24.2%, after the investment bank pre-announced earnings and investors reacted to speculation the company may be compelled to find a buyer. Read more.

"The carnage in the financial markets has taken down several pillars of the U.S. financial system, including Bear Stearns, Lehman Brothers, and Merrill Lynch, and currently threatens Morgan Stanley and Goldman Sachs," said analysts at Action Economics.

Lehman LEH, plunged 56.7%.

Outside the financial sector, Longs Drugs Stores Inc. LDG, -0.80% rejected an unsolicited bid from Walgreen Co. WAG, , recommending instead that shareholders accept a lower offer previously made by CVS Caremark Corp. CVS, -0.69% . Read more.

Overseas, shares in Europe slid into the red, with the pan-European Dow Jones Stoxx 600 index finishing 2.1% lower in a third day of losses in excess of 2%. Read Europe Markets.

In Asia, markets ended mixed, with the Hong Kong's Hang Seng Index falling 3.6% to end at 17,637.19, its lowest level since October 2006. See Asia Markets.

On Tuesday, U.S. stock indexes climbed on reports of an imminent AIG rescue, with the market largely bypassing the Fed's decision to leave its benchmark lending rate unchanged at 2%. Read The Fed.