The Dow Jones Industrial Average dropped 114 points, or 0.9%, to 13,436 points. Of the Dow's 30 components, only two were trading higher.
Among the biggest decliners was Citigroup , which fell 2.2% to $29.78.
The S&P 500 Index dropped 10.27 points, or 0.7%, to 1,487 and the Nasdaq Composite fell 22.45 points, or 0.8%, to 2,702.
"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 surged to trade above $97 a barrel on the news of Bhutto's death, as energy traders worried about increased tensions in the Middle East.
The decline in stocks "has a lot to do with the assassination in Pakistan," said Marc Pado, U.S. market strategist at Cantor Fitzgerald. "It's destabilization in a region with a country the United States is semi-friendly with. We consider them on our side."
"The markets are thin. It doesn't take much news -- good or bad -- to move the market," Pado said. "The reaction is in oil pushing back toward $100."
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.
On the New York Stock Exchange, over 309 million shares exchanged hands, with decliners outpacing advancers 7 to 3. On the Nasdaq, over 494 million shares were traded, with decliners outpacing advancers 20 to 7.
"Trying times" ahead
"My guess is we've got some trying times ahead," said Phil Dow, the director of equity strategy for RBC Dain Rauscher. Bhutto's assassination is one factor.
"The geopolitical risk and uncertainty always plays a role, and my guess is this is part of the reason the market's down today," Dow said. "Also, you've got people beginning to worry about the relatively high earnings expectations next year, and then how financial stocks do when they report earnings in early to mid-January."
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 6.9%. Late Wednesday, the company said it would raise $2.5 billion through offerings of common and preferred stocks.
Of other stocks in focus, Apple gained 1.3% at $201.46 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 thantwo 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 rose for a fourth day, shooting near $835 an ounce earlier, as news of Bhutto's death heightened the metal's appeal as a safe-haven investment. A sliding dollar also put upward pressures on the precious metal.
U.S. Treasury bonds rallied Thursday, sending yields lower, as investors fled to the safety of fixed income assets.
The dollar was lower Thursday, as the euro rallied following reports of Bhutto's death as well as disappointing U.S. durable goods orders and weekly jobless claims data.
By Polya Lesova