The Dow Jones Industrial Average fell 61 points, or 0.5%, to 13,489. Of the Dow's 30 components, only three were trading higher.
Among the biggest decliners was Citigroup , which fell 2.4% to $29.73.
The S&P 500 Index dropped 7 points, or 0.5%, to 1,490 and the Nasdaq Composite fell 10.38 points, or 0.4%, to 2,714.
"The market may be coming down on the fact that we heard news of the assassination. ... That might be causing come nervousness in the market," said Peter Cardillo, chief market economist at Avalon Partners.
The drop in stock futures followed media reports that Pakistani opposition leader Bhutto was killed following a suicide bombing that also killed at least 20 others who attended a political rally in Rawalpindi, Pakistan.
Crude-oil futures also surged on the news of Bhutto's death, as energy traders worried about increased tensions in the Middle East.
On Wednesday, U.S. stocks finished with mild gains amid concerns over holiday retail sales and downbeat housing data. The Dow industrials rose 2 points, the Nasdaq Composite rose 10 points and the S&P 500 added a point.
"We're probably headed for sluggish day," Cardillo said. "We might see a repeat of yesterday's trading action."
On the New York Stock Exchange, over 141 million shares exchanged hands, with decliners outpacing advancers 17 to 10.
On the Nasdaq, over 222 million shares were traded, with decliners outpacing advancers 15 to 9.
The credit crunch is back in the spotlight after Fitch Ratings put 205 residential mortgage-backed securities backed by bond insurers including MBIA Inc. and Ambac Financial under review for downgrades.
Meanwhile, Goldman Sachs analysts increased their write-down estimates for Citigroup , Merrill Lynch and J.P. Morgan Chase , and predicted Citigroup will have to slash its dividend by 40%. Shares of all three declined on Thursday.
SLM Corp. , parent of student-loan giant Sallie Mae, tumbled 6.3%. Late Wednesday, the company said it would raise $2.5 billion through offerings of common and preferred stocks.
Of other stocks in focus, Apple edged up to just below $200 after the Financial Times reported that the 20th Century Fox unit of News Corp. has reached a deal to allow consumers to rent the studio's recent releases through Internet downloads. News Corp. also owns MarketWatch, the publisher of this report.
Disappointing economic data also added to the negative tone.
Excluding transportation orders, durable goods orders fell by 0.7% in November, the Commerce Department reported. Economists surveyed by MarketWatch were expecting orders for durable goods to climb by 2.9% in November after falling by 0.2% in October.
Separately, seasonally adjusted first-time jobless claims nudged up in the most recent weekly data, while continuing claims reached the highest level in more than two years, government data showed.
U.S. consumer confidence rose in December due to an increase in short-term expectations, though consumers "remain far from optimistic," the Conference Board reported Thursday.
The consumer confidence index rose to 88.6 from a revised reading of 87.8 in November. The initial estimate for November was 87.3.
Gold futures for February delivery rose $2.80 at $832.30 an ounce on the New York Mercantile Exchange.
U.S. Treasury bonds rallied early Thursday, sending yields lower, as traders fled to the safety of government bonds. The benchmark 10-year Treasury bond rose 16/32 to 100 8/32, its yield falling to 4.219%.
The dollar was lower Thursday, as the euro rallied following reports of Bhutto's death as wel as disappointing U.S. durable goods orders and weekly jobless claims data. The dollar index, which tracks the greenback against a basket of six major currencies, was at 76.870, down from 77.180 late Wednesday.
By Polya Lesova