NEW YORK/WASHINGTON (Reuters) - U.S. lawmakers rejected a $700 billion bailout plan for the financial industry in a shock vote that sent global markets sliding as the world credit crisis claimed more banks.

By a vote of 228-to-205 the House of Representatives rejected a compromise plan that would have allowed the Treasury Department to buy up toxic debt from struggling banks.

The plan’s defeat sent U.S. stocks down sharply, with the Dow Jones industrial average briefly falling more than 700 points, its biggest intraday drop ever.

Shares had already been under pressure following sharp declines in Asian and European shares on fears the crisis was spreading. Global money markets remained frozen, even as central banks poured in cash in an attempt to boost liquidity.

Capping three hours of debate on Capitol Hill, House Majority Leader Steny Hoyer of Maryland had warned lawmakers that the cost of inaction would be an economic calamity beyond Wall Street.

“A meltdown would begin, it is true, on a few square miles of Manhattan, but before it was over, all of us know, no city or town in America would be untouched,” Hoyer said.

When the contentious bailout plan was announced by the Bush administration last week, some House Republicans balked at spending so much taxpayer money just before U.S. elections.

Republican House members voted against the bailout by a more than 2-to-1 margin. A majority of Democrats voted in favor.

President George W. Bush had urged lawmakers to pass the bailout package quickly, saying it was needed to keep the financial crisis from spreading.

The showdown on the bailout proposal came too late for Wachovia Corp, which agreed to sell most of its assets to Citigroup Inc in a deal brokered by the Federal Deposit Insurance Corp.

The Dow Jones industrial average was down more than 4 percent and the broader S&P 500 index was down nearly 6 percent. Oil fell $8 a barrel.

Earlier, European shares dropped to a three-and-a-half year closing low with bank shares weighing heavily.

“Investors are fearful, frenetic, especially when it comes to banking shares. They want to get out now and see the after effects from afar,” said Frank Geilfuss, head analyst at Bankhaus Loebbecke.

A flag hangs outside the New York Stock Exchange September 22, 2008. REUTERS/Eric Thayer

Around the world, investors were dumping assets they regarded as risky. World stocks were down sharply, while gold and U.S. Treasuries surged in the rush to safety.

The world’s central banks, led by the U.S. Federal Reserve, announced a $330 billion expansion of currency swap arrangements, which allows them to increase the amount of money they can provide in their home markets, effectively throwing more money at the crisis.

Earlier, the governments of Belgium, the Netherlands and Luxembourg moved to partly nationalize Belgian-Dutch group Fortis NV with an injection of more than $16 billion, and German lender Hypo Real Estate Holding AG secured a credit line from the German government and banks of up to 35 billion euros.

“The contagion is spreading to mainland Europe and everyone’s asking, ‘Who’s next?’” said Mark Sartori, head of European sales trading at Fox-Pitt, Kelton in London.

The Wachovia deal is the latest in a series of events that has transformed the American financial landscape and wiped out hundreds of billions of dollars of shareholder wealth.

The changes include the government takeover of mortgage finance companies Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers Holdings Inc, the failure of giant savings and loan Washington Mutual, and Bank of America Corp’s purchase of Merrill Lynch & Co Inc.