Updated from 4:11 p.m. EST

Stocks in New York closed deep in negative territory Wednesday following dour economic comments from the Federal Reserve chief, further data pointing to a U.S. slowdown and more bad news from the financial industry.

The Dow Jones Industrial Average plunged 306.95 points, or 2.46%, to 12,159.21, its lowest close since March 16 of last year. Each of the Dow's 30 components finished with losses, led by 6% declines in Alcoa ( AA), Merck ( MRK), and AIG ( AIG).

The S&P 500 sank 39.95 points, or 2.91%, at 1333.25, and the Nasdaq Composite tumbled 47.69 points, or 1.99%, to 2346.90.

The major averages have now suffered a three-day decline that has cut the Dow by 4.8%, the S&P 500 by 5.9%, and the Nasdaq by 5.3%. The Dow has fallen 2,005 points, or 14.1%, since recording its record close on Oct. 9.

Financials were the biggest lag on the market following news of a massive loss at Merrill Lynch ( MER) and potential ratings trouble for bond insurer Ambac ( ABK), which could further roil the mortgage market.

The Amex Securities Broker/Dealer Index dropped 5.5%, the KBW Bank Index lost 4.7%, the Nasdaq Financial 100 Index was down 3.9%, and the NYSE Financial Sector Index fell 3.3%.

Breadth was dismal and volume was heavy. On the New York Stock Exchange, 5.48 billion shares changed hands, as decliners topped advancers by more than a 5-to-1 margin. Volume on the Nasdaq reached 2.76 billion shares, with losers beating winners roughly 4 to 1.

The broad market turned south after Fed Chairman Ben Bernanke, speaking before Congress about his economic outlook, provided a downbeat forecast that overshadowed his support for stimulus. The Fed is holding a two-day meeting at the end of the month, and most traders are already expecting a 50-basis point reduction in the fed funds rate.

During his remarks, the central bank chief said financial conditions continue to pose a threat to the economy and that "additional policy easing may well be necessary" because the outlook for activity in 2008 has worsened. The "downside risks to growth have become more pronounced," he said.

Echoing his comments of last week, Bernanke said that if required, policy makers will "take substantive additional action" to support growth and protect against a downturn.

Paul Mendelsohn, chief investment strategist with Windham Financial, said that Bernanke indicated the Fed finds no immediate need to cut rates, something the market was unhappy with.

"For now, he's attempting to calm the fears and keep the market from talking itself into a recession," said Mendelsohn. "He doesn't want to provide too much liquidity, but he has to provide enough that the Fed is still in control."

Robert Pavlik, chief investment officer with Oaktree Asset Management, said that a 50-basis-point cut from the Fed may not be enough to spur buyers as the economic picture worsens.

"We now need a much larger rate cut than is already baked in to stop this slide from going lower," said Pavlik. "It feels like traders have thrown in the towel. It takes a lot of discipline to hit the sell button, even on some of the high-quality names. Eventually we'll find a bottom and focus will begin to change, but for now this is a dramatic loss of capital."

Bernanke also endorsed a short-term, temporary stimulus package in order to keep the economy from falling into a recession, but stressed it would need to be implemented in a timely fashion.

The day's data did little to suggest a downturn can be avoided. The Philadelphia Fed disappointed traders after releasing its manufacturing index, which came in at a reading of negative 20.9, compared with a negative 1.6 in December. The drop was far greater than economists had anticipated.

"The two most important indicators within the report, namely new orders and production, fell significantly on a month-over-month basis," said Michael Sheldon, chief market strategist with Spencer Clarke LLC. "Prices paid also rose last month, indicating the firms are gaining increased pricing power."

Another sign of weakness came when the Census Bureau said housing starts plunged 14.2% last month to 1.006 million annualized units, the lowest level in nearly 17 years. Additionally, building permits dropped 8.1% to 1.068 million. Both were well below consensus.

On the positive side, the Labor Department said initial jobless claims unexpectedly fell by 21,000 last week to 301,000. Claims are at their lowest level since May.

However, Ian Shepherdson, chief economist with High Frequency Economics, said the decline didn't make sense. "All the evidence suggests conditions in the labor market are deteriorating," he said. "Sudden dips like this are almost invariably followed by a rebound, and we expect claims to surge over the next few weeks."

Writing for RealMoney.com, Tony Crescenzi, chief bond market strategist at Miller Tabak, said the numbers "clearly suggest problems with seasonal adjustment and should be tossed." The reading was low, he wrote, "but repeats a recurring pattern of decreases occurring at the start of the year, a pattern that has seen claims jump back to trend in the weeks that followed."

U.S. Treasury prices rallied. The 10-year note rose 1-2/32 in price, yielding 3.61%. The 30-year bond surged 1-28/32 in price, yielding 4.24%. The dollar was falling against the world's major currencies.

Among stocks, Merrill Lynch tumbled 10.2% to $49.45 following its report of a fourth-quarter loss of almost $10 billion and a writedown $14.6 billion.

Ambac was another straggler, and its decline was much worse. The stock plummeted 51.9% to $6.24 on word Moody's might downgrade the financial strength ratings of Ambac units, and as a result, the ratings of the debt issuers it insures.

Competitor MBIA ( MBI) sank 31.2% to $9.22.

Bank of New York Mellon ( BK), meanwhile, reported a $118 million writedown during the fourth quarter that forced profit lower by 68% from a year ago. Its shares ended down 0.7% at $44.77.

Commodity futures were slightly lower. Oil was down 71 cents to close at $90.13 a barrel. Gold was off $1.50 to close at $880.50 an ounce.

Overseas markets traded unevenly. Overnight in Asia, Japan's Nikkei 225 rose 2.1%, and Hong Kong's Hang Seng gained 2.7%. Among European bourses, London's FTSE 100 and Germany's Xetra Dax eased 0.7%.

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