Major stock indexes fell about 2 percent from 13-month highs, including the Dow Jones industrial average, which slid 200 points in the first minutes of a shortened trading day.
Trading volume had been expected to be light after the Thanksgiving holiday. Light volume can trigger big swings in markets. Stock markets close three hours early, at 1 p.m. EST. Bond markets close at 2 p.m.
Investors' broad retreat from riskier assets pushed Treasury prices up sharply. The dollar gained against most other major currencies as investors sought safety following steep drops in overseas markets. Commodities prices tumbled.
Investors are worried that a default by a government investment company in Dubai over $60 billion in debt payments could have a ripple effect in world financial markets. The fear is that losses in the small emirate, which has drawn wealthy tourists from around the globe in the past decade with its Las Vegas-in-the-Middle East appeal, could imperil a nascent economic rebound.
Worries about bad debt are fresh in investors' minds after the collapse of the U.S. brokerage Lehman Brothers in September last year pushed the world overnight deeper into recession as banks halted lending on fears of a domino effect of bad loans.
"I think this is a sign of things to come," said Dave Rovelli, managing director of trading at brokerage Canaccord Adams in New York. "Commercial real estate continues to go lower. People are going to continue to default on debt payments."
Investors are being forced to ask whether the troubles in Dubai will usher in a new period of financial instability and put in danger an eight-month rally in the stock market. However, the ability of world markets to digest the troubles in Dubai without widespread panic could also boost investor confidence in the recovery in the financial markets in the past year.
The latest trouble on Wall Street come as the U.S. kicks off the unofficial start to the holiday shopping season. Investors will be tracking news from retailers for insights into how much consumers will spend in the coming month. Consumer spending is the biggest driver of the U.S. economy.
In the first minutes of trading, the Dow Jones industrial average fell 196.27, or 1.9 percent, to 10,268.13. The broader Standard & Poor's 500 index fell 23.65, or 2.1 percent, to 1,086.98, and the Nasdaq composite index fell 44.89, or 2.1 percent, to 2,131.16.