By Ellis Mnyandu
Data pointing to the slowest start rate in home building in more than 17 years highlighted the deterioration in housing.
Fanning gloom about the financial sector was a forecast by JPMorgan Securities that investment bank Lehman Brothers <LEH.N> will likely take a further $4 billion of write-downs in the third quarter due to losses from mortgage-related investments.
Lehman shares fell more than 4 percent as the S&P financial index <.GSPF> declined 1.4 percent.
The government's Producer Price Index shot up at the fastest annual rate in 27 years, while core producer prices, excluding volatile food and energy, notched their fastest rise since November 2006. Investors feared the specter of inflation could hinder the Federal Reserve's efforts to spur growth by keeping interest rates low.
"The Fed is stuck between a rock and a hard place, and it shows," said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco. "The market is struggling a bit."
The Dow Jones industrial average <.DJI> fell 122.94 points, or 1.07 percent, to 11,356.45. The Standard & Poor's 500 Index <.SPX> slid 11.18 points, or 0.87 percent, to 1,267.42. The Nasdaq Composite Index <.IXIC> declined 23.41 points, or 0.97 percent, to 2,393.57.
Shares of Bank of America <BAC.N> , down more than 2 percent, were a top drag on the S&P 500, while American Express <AXP.N> , down 2.6 percent, weighed on the Dow.
"We are back to struggling again in the financial sector particularly," said William Stone, chief investment strategist at PNC Financial in Philadelphia. "Underneath some of that is just concern about the overall global economic slowdown."
If interest rates were to rise, that would increase borrowing costs for businesses and consumers and exacerbate the impact of the housing slump.
Lehman shares fell to $14.30 on the New York Stock Exchange, where shares of Bank of America, the No. 2 U.S. bank, declined to $28.09. Shares of credit card and travel services company American Express dropped to $36.81.
Shares of American International Group Inc <AIG.N> fell more than 4 percent to $20.66 after Goldman Sachs cut its price target on the insurer's stock.
Shares of home builders also slid following the Commerce Department's bleak report on housing starts.
Shares of Pulte Homes <PHM.N> , the No. 3 U.S. home builder, declined 1.5 percent to $12.32.
On Nasdaq, shares of Staples Inc <SPLS.O> tumbled nearly 5 percent to $23.36 after the leading U.S. office supply chain said tough market conditions hurt quarterly results.
The PPI data supported those arguing that the U.S. economy is dogged by mounting inflationary pressures even as growth slows due to the housing downturn. July's Consumer Price Index last week rose at the fastest pace in 17 years.
(Additional reporting by Herb Lash; Editing by Kenneth Barry)