Treasury secretary Henry Paulson's $700 billion plan - which would have seen many banks' most toxic assets taken into government hands - was rejected by Congress after a majority of house Republicans voted against it.
There was near-panic on the New York Stock Exchange following the announcement, and the Dow closed 777 points down.
Overall, it was a day of almost unprecedented bad news for the financials.
Five banks around the world were given government bailouts, as investors continued to lose confidence in the financial services sector.
Speaking to the Guardian Peter Morici, professor of business at the University of Maryland, said: "Things are going to get so bad something will have to be done in the next few weeks.
"Banks will sink, credit markets will seize, the economy will go into something much worse than a recession."