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A Filipino trader reads a newpaper during trading ends at the Philippine Stock Exchange in suburban Makati, south of Manila, Philippines, on Wednesday, Aug. 10, 2011.

Aaron Favila/AP

Global stocks slumped on Wednesday as risk appetite evaporated on speculation about the strength of French banks holding troubled Greek and Italian debt.

The rumours tapped into investors' worst fears of contagion from euro zone debt troubles and led European markets lower. French bank stocks were hit hard.

The turnaround in equities followed a morning of gains in Europe and Asia prompted by the U.S. Federal Reserve's dovish promise on Tuesday that it would keep interest rates low for another two years.

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Shares of Société Générale SA plummeted as much as 23 per cent before trimming some losses to trade down 14.7 per cent. BNP Paribas dove 9.5 per cent.

A Société Générale spokeswoman denied all market rumours about the bank. It also asked France's stock market regulator to open an investigation into the source of the rumours.

Losses in bank shares also sent Wall Street lower following two days of extreme volatility that included the sharpest drop in nearly three years on Monday after Standard & Poor's downgraded its triple-A credit rating for the United States.

U.S. and European indexes tumbled by more than 3 per cent. The euro dropped more than 1 per cent against the dollar.

"Memories are fresh. I think people who during the last financial crisis did not sell right away, next time around are ready to sell quick and ask questions later," said Ed Crotty, chief investment officer at Davidson Investment Advisors in Great Falls, Mont.

Wall Street's favourite fear gauge, the CBOE Volatility index, jumped 13.2 per cent after earlier rising more than 20 per cent. It was the third session in the last five the index has seen a jump of at least 20 per cent.

Speculation France's triple-A rating may be at risk initially rattled markets, though the three major agencies reaffirmed the top-tier rating.

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"I think there's concern about just how much Greek debt French banks really do hold and how much the European Central Bank is willing to backstop all this," said Bret Barker, portfolio manager at TCW in Los Angeles, which has $65-billion (U.S.) in fixed-income assets under management.

Recent selling has followed attempts by politicians and central banks on both sides of the Atlantic to prevent or contain debt crises.

Not surprisingly, the relief rally sparked by Tuesday's Fed comments turned out to be short lived.

Investors saw the Fed message as double edged. The central bank signalled it was willing to keep the U.S. economy afloat. At the same time, it acknowledged just how much trouble the world's largest economy was in.

By mid afternoon Wednesday indexes had given up a chunk of Tuesday's gains.

The Dow Jones industrial average plunged 459.25 point, or 4.09 per cent, to 10,780.52. The Standard & Poor's 500 Index lost 44.34 points, or 3.78 per cent, to 1,128.19. The Nasdaq Composite Index slid 84.04 points, or 3.39 per cent, to 2,398.48.

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However, in Toronto, the S&P/TSX composite index rose 41.78 points, or 0.36 per cent, to 12,151.04.

The MSCI all-country world index, which has fallen as much as 20 per cent from a May high, was down 1.4 per cent after earlier gains. The FTSEurofirst 300 of leading European shares closed down 4 per cent.

The euro traded down 1.2 per cent at $1.4190, after sliding to a session low of $1.41620 on trading platform EBS. It lost 2.1 per cent to ¥108.42.

The search for safety drove investors into U.S. Treasuries and gold. The benchmark 10-year Treasury note was up 23/32 in price after briefly posting a full point gain, its yield falling to 2.16 per cent, down from 2.24 per cent late on Tuesday.

The 30-year Treasury bond was up 2-3/32 in price to yield 3.53 per cent, down from 3.68 per cent at Tuesday's close.

Gold racked up a third record in a row, extending its best rally since 2008. Spot gold rose near 3 per cent to hit a high of $1,796.86.

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