By Claudia Parsons
NEW YORK (Reuters) - Federal Reserve Chairman Ben Bernanke warned on Wednesday that credit market turmoil posed a "significant threat" to an already slowing American economy as new data deepened recession fears, sending stocks tumbling.
Major U.S. stock indices fell as much as 7 percent.
European leaders meeting in Brussels called for a new world financial order to prevent future crises. Britain and Germany joined France in calling for an international summit this year to draw up a new world financial system.
The United States reported its biggest monthly decline in retail sales in more than three years and Europe offered negative economic data and outlooks of its own.
Earlier this week, governments around the world pledged $3.2 trillion in emergency measures, including taking stakes in banks to help them stabilize, which led to a rally in world markets on Monday.
But that optimism was quickly overshadowed by fears that major economies are headed for recession despite the government intervention.
"By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth," Bernanke said on Wednesday.
Bernanke said the central bank's concerns about inflation were diminishing and that it would take some time to restore normal flows of credit.
U.S. stock market declines accelerated and the dollar rose against the euro after his comments.
The Dow Jones industrial average fell 5.2 percent and the S&P 500 index was down 6.3 percent.
"It looks like everything that's economically sensitive is getting hit pretty good," said Scott Vergin, portfolio manager at Thrivent Financial in Minneapolis, Minnesota.
"The thing is how much has the credit crunch already impacted the real economy?" added Vergin. "That's what everyone's really worried about."
European shares shed 6 percent. Oil fell more than $3.
SUMMIT TO REFORM FINANCIAL SYSTEM
In Brussels, British Prime Minister Gordon Brown and German Chancellor Angela Merkel backed a proposal by French President Nicolas Sarkozy to hold a meeting to revamp financial structures set up at the Bretton Woods conference in 1944.
"I believe a forum to decide on big changes in the international economy can be held in the next few months," Brown told a news conference just before a two-day summit.
Dutch Finance Minister Wouter Bos said a stronger role for the International Monetary Fund was needed, "in the absence of American leadership at the moment."
The United States on Tuesday offered to take up to $250 billion worth of equity in its banks, an astonishing move in the home of free market capitalism.
President George W. Bush stressed that the move was temporary. "I'm confident in the long run this economy will come back," he told reporters before a cabinet meeting on Wednesday.
The U.S. move followed an agreement by European leaders on Sunday to undertake a 2.2 trillion-euro ($3 trillion) rescue of European banking giants, which have been hit by a credit crunch brought on by defaulting mortgages in the United States.
The Group of Eight industrial countries said on Wednesday they were united in their commitment to confront the financial crisis.
The G8 said changes to regulatory regimes were needed, and that they would hold a leaders meeting with key countries "at an appropriate time in the near future to adopt an agenda for reforms."
"While our focus now is on the immediate task of stabilizing markets and restoring confidence, changes to the regulatory and institutional regimes for the world's financial sectors are needed to remedy deficiencies exposed by the current crisis," said a statement released by the White House.
DATA POINTS TO RECESSION
Signs of a looming recession abounded on Wednesday.
The U.S. government said retail sales dropped 1.2 percent in September, the biggest monthly drop in three years, and wholesale prices slipped 0.4 percent. Manufacturing activity in New York state fell in October.
The Federal Reserve's Beige Book report said economic activity weakened across the United States in September as businesses revised capital investments and consumers curtailed spending.
U.S. bank JPMorgan Chase said third-quarter profit plunged 84 percent, while Wells Fargo reported a drop in earnings of 25 percent.
British unemployment rose to 5.7 percent, its highest level in eight years, official data showed.
German economic growth will only be slightly above zero in 2009, Finance Minister Peer Steinbrueck said.
The European Central Bank said it would allow banks to swap a larger range of their assets for central bank funds and offer extra U.S. dollar liquidity through foreign exchange swaps.
Southeast Asian nations, backed by $10 billion from the World Bank, were the latest to join the rescue effort, agreeing to create a multibillion fund to help banks.
The fund will buy up toxic debt and support banks in the region, Philippines President Gloria Macapagal Arroyo said.
Iceland, driven close to bankruptcy as frozen credit markets caused its banks to fail, cut interest rates a staggering 3.5 percentage points as its officials pursued efforts to get help from Russia via a multibillion-euro loan.
The economy is dominating the U.S. presidential campaign, which sees a final debate between the candidates on Wednesday.
Democrat Barack Obama has accused Republicans of presiding over unfettered financial deregulation while John McCain has sought to regain his footing on economic issues after drawing criticism for saying U.S. fundamentals were strong.
(Reporting by Reuters bureaus around the world; Editing by Steve Orlofsky)
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