Just as eurozone finance ministers approved a bailout for Spain's banks, one of the country's regions, Valencia, said it would become the first to tap a new fund designed to provide liquidity to the country's 17 semi-autonomous regions.
The government also predicted that the recession would continue into 2013.
Spanish markets slumped, with the Ibex stock index down 5.82 percent. The yield on Spanish 10-year bonds shot up 0.25 percentage points to 7.22 percent on the news.
Britain's FTSE 100 was down 1.09 percent at 5,651.77 while Germany's DAX lost 1.9 percent to 6,630.02. France's CAC 40 shed 2.14 percent to 3,193.89.
In Milan, the main Italian stock index fell 4.4 percent after Premier Mario Monti said the debt crisis had spread to Italy and that the country would try to avoid requesting a bailout. Italy's 10-year bond yield rose by a sharp 0.25 percentage points, to 6.16 percent.
The euro fell sharply, trading 0.9 percent lower on the day to $1.2163, the lowest level in two years.
News that finance ministers in the 17-country eurozone had unanimously approved the terms for bailout loan for Spanish banks of up to (EURO)100 billion ($122.9 billion) failed to lift the gloom.
They signed off on a document that calls for strict monitoring of the banks that receive aid.
However, the decision was largely as expected, leaving investors to focus on the other, darker news from Spain.
On Wall Street, stocks likewise fell, though not as much—the Dow was down 0.97 percent to 12,775.0 while the S&P 500 also fell 0.97 percent to 1,363.
Bank stocks were down though tech stocks, including Google and Microsoft, were up. Google's earnings rose as it persuaded users to click more often on online ads.
Stocks had performed well earlier this week, thanks to some upbeat corporate earnings, and hopes that the Federal reserve will in coming months announce new pro-growth stimulus measures—the jobs market is stagnant and many businesses are scaling back on production.
In a testimony to Congress this week, Fed Chairman Ben Bernanke gave no indication the central bank is considering imminent new stimulus but said it remains ready to act.
The latest data confirmed the U.S. economy is struggling. Weekly jobless claims rose 34,000 to a three-week high of 386,000 and an indicator of regional manufacturing was much weaker than anticipated. Homes sales and leading economic indicators were also soft.
In Asia, Japan's Nikkei 225 fell 1.4 percent to 8,669.87 while Hong Kong's Hang Seng added 0.4 percent to 19,640.80. Australia's S&P/ASX 200 shed 0.1 percent to 4,199.10 and China's Shanghai Composite dropped 0.7 percent to 2,168.64.
Markets in Singapore, India, Indonesia, Thailand, Malaysia and New Zealand also fell.
Benchmark oil was down $1.55 at $91.41 a barrel in electronic trading on the New York Mercantile Exchange. The contract surged $2.79, about 3 percent, to $92.66 in New York on Thursday, its highest level since mid-May.