Italy paid a record euro-era high to sell five-year bonds, a day after former European Commissioner Mario Monti was named to lead the country -- a move that had been hoped would help restore market confidence.
German Chancellor Angela Merkel said Europe may be living through its toughest hour since World War Two as the new leaders in Italy and Greece rushed to form governments and limit damage from the debt crisis.
Merkel said she feared Europe would fail if the euro failed. But she offered no new ideas for resolving a crisis that has forced bailouts of Greece,Ireland and Portugal, and stirred doubts about the survival of the 17-nation currency area.
Analysts said that despite the political moves taken to stem the crisis, a high level of uncertainty was holding a tight grip on investor confidence.
Mark McCormick, currency strategist at Brown Brothers Harriman in New York, called the move to install national unity governments in both Italy and Greece "the necessary policy response to avert a meltdown." But, he said, "This is unlikely to be a silver bullet and many questions still remain.
"Outside of brief short covering rallies, we expect the euro to remain under pressure," he said.
The euro on Monday was down 1.3 percent at $1.3622.
On Wall Street, the Dow Jones industrial average closed down 74.70 points, or 0.61 percent, at 12,078.98. The Standard & Poor's 500 Index fell 12.07 points, or 0.96 percent, at 1,251.78. The Nasdaq Composite Index shed 21.53 points, or 0.80 percent, at 2,657.22.
European economic data also weighed on sentiment, suggesting the debt crisis was taking a toll on the economy. Industrial production in the euro zone recorded its biggest decline in September since early 2009, falling 2 percent.
"The markets are realizing there are real economic problems in Europe," said Christophe Barret, global oil analyst at French bank Credit Agricole.
European shares fell further as Italy's bond auction showed investors were still reluctant to buy any more Italian debt, although trading volumes were thin as progress was awaited on the forming of a new government.
The FTSEurofirst 300 index of top European shares fell 0.9 percent to close at 975.47 points. Italy's FTSE MIB index fell 2.0 percent.
Much uncertainty remains regarding the European financial crisis," said Markus Huber, head of German sales trading at ETX Capital. "Many are in no rush to enter the market as they are confident that they will be able to buy stocks cheaper at a later time."
The sale of 3 billion euros ($4.12 billion) of five-year bonds, small by Italian standards, met slightly improved demand compared with a month ago. But the 6.29 percent cost of borrowing was seen as unsustainable as Italy tries to refinance its 1.9 trillion euro debt.
Italian 10-year yields rose to 6.76 percent as prices fell 164 ticks. Yields had fallen to 6.40 percent early on Monday following the change in Italy's government and debt purchases by the European Central Bank, but later rose.
In a sign of investor angst, Spanish 10-year bond yields rose above 6 percent for the first time since the ECB started to buy the country's bonds in August.
Spanish 10-year government bond yields increased to 6.13 percent.
U.S. Treasuries prices rebounded in a bid for safety.
The benchmark 10-year U.S. Treasury note was up 6/32 in price to yield 2.04 percent.
Crude oil prices fell after the weak euro zone data highlighted the possibility of a regional recession.
Brent crude settled down $2.27 at $111.89 per barrel. U.S. crude settled down 85 cents at $98.14.
Gold fell on a stronger dollar at it tracked riskier assets. Trading volume was on track to be one of the weakest sessions of the year.
U.S. gold futures for December delivery settled down $9.70 at $1,778.40 an ounce.