The Dow Jones Industrial Average was down 185 points at 13,475, with 25 of its 30 components trading in the red, with American International Group Inc. leading the Dow's losses.
AIG's stock fell 4.3% after the world's largest insurer said residential mortgage delinquencies and defaults are climbing, signaling damage in the mortgage market could be expanding.
"Right now, we're going through a massive liquidation in futures," said Peter Cardillo, chief market economist at Avalon Partners. "We're in for a very volatile session," he said. "It's not only equities, we're seeing large drops in oil and gold as well."
The S&P 500 lost 24.3 points to 1,477.2, while the Nasdaq Composite lost 28.8 points to 2,584.2.
Markets seemed as if they were just getting over concerns about credit markets and bad U.S. home loans.
But French banking group BNP Paribas said Thursday that it has suspended three funds with exposure to the U.S. credit markets as it has become impossible to accurately value them after "the complete evaporation of liquidity.
Following the news, the European Central Bank said it allocated 94.841 billion euros to 49 bidders in a one day quick tender at 4.0% to add liquidity to the money market.
Separately, Wal-Mart Stores said its July sales at stores open at least one year rose 1.9%. Analysts, on average, had expected the same-store sales to rise 1.5%.
U.S. stocks closed higher Wednesday after a volatile trading say that saw the Dow claw its way back from a 190-point deficit in the final hour of trading as investors remained positive about the Federal Reserve's assessment of economic growth and also cheered an upbeat outlook from Cisco Systems. The S&P 500 closed up 20.78 points and the Dow industrials were 153.6 points ahead at the close.
In currency markets, the dollar rallied against the euro but lost ground against the yen as credit market jitters remained and ahead of the latest data on U.S. jobless claims.
The dollar slipped 0.8% against the yen to 118.76, while the euro lost 0.5% against the greenback to $1.3732.
Oil prices slumped, with the September-dated light crude contract down $1.25 at $70.91 a barrel.
By Kate Gibson