Bank stocks and the broader market fell sharply Monday as the market digested permanent alterations to the financial landscape: the exit of two New York investment banks and the system's exposure to steep losses at one of them.

The KBW Bank Index fell 8.42%. The Dow Jones industrial average fell 4.42%, and the Standard & Poor's 500 fell 3.69%, despite efforts by bankers and regulators to calm investor fears, including the creation of a $77 billion fund to aid troubled companies.

Bank of America Corp.'s shares fell more than 21%. The Charlotte company agreed late Sunday to acquire Merrill Lynch & Co. Inc. for $50 billion of stock. Merrill's shares rose 0.06%.

Anthony Polini, an analyst at Raymond James & Associates, said some investors may be wondering if the deal for Merrill will worsen B of A's risk profile in the near term. "But long term, I'd be surprised if this wasn't a big plus for Bank of America."

B of A "has priced for risk in its deal for Merrill," he said. Since investment bank stocks generally pick up momentum midway through an economic recovery, the deal for Merrill "should give Bank of America a much more sustainable stock price throughout the recovery."

Lehman Brothers' share value was all but erased Monday when the company filed for bankruptcy protection after failing to find a lifeline over the weekend. Lehman's shares dropped 94.3%.

American International Group Inc. shed nearly 61%, even though Gov. David Paterson of New York gave the troubled insurer special permission Monday to access $20 billion of capital from its subsidiaries, according to Bloomberg News.

Bank stocks "were under pressure from the moment I walked in to the moment the market closed," said Anthony Conroy, head trader at Bank of New York Mellon Corp.'s BNY ConvergEx Group. "There's a tremendous amount of nervousness in the sector, which breeds a tremendous amount of volatility."

Bert Ely, a banking consultant in Alexandria, Va., said that much of the nervousness is due to the "continuing uncertainties of the housing market's impact and how all of the financials are going to play out."

"That's why we may have heavy selling of the good, along with the not so good," Mr. Ely said.

But in future sessions, the market may start to discriminate again between those who continue to be plagued by problems, from those that really dodged the bullet, Mr. Ely said.

Gary Townsend, the president and CEO of Hill-Townsend Capital LLC, said investors may also have been reacting to the possibility that the Federal Reserve Board will cut the federal funds rate, "perhaps as early as tomorrow."

Morgan Stanley and Goldman Sachs Group Inc., the remaining stand-alone investment banking companies, also dropped Monday. Morgan Stanley fell 13.5%, and Goldman Sachs fell 12.1%.

Citigroup Inc. fell 15.1%, despite an effort by Vikram Pandit, the New York company's CEO, to assure investors.

"It is important that we maintain our unrelenting focus on the needs and concerns of our clients and shareholders," Mr. Pandit wrote in an internal memo. (See related story.) "They will want our views on the ongoing market dislocation. Please assure them of the entire industry's commitment to work together through this transition."

Washington Mutual Inc. fell almost 27%. Investors continued to react to the uncertainty of the Seattle thrift company's future as independent company.

Wachovia Corp. dropped 24.9%. JPMorgan Chase & Co. declined 10.1%. Bank of New York Mellon Corp. fell 8.5%; and Central Bancorp Inc. in Somerville, Mass., fell 27.7%.

There were some gainers. Royal Bancshares of Pennsylvania in Narbeth rose 9.7%, and Timberland Bancorp in Hoquiam, Wash., rose 7.7%.

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