North American stock markets dropped sharply again Wednesday, one day after the U.S. federal government announced it would provide a massive loan to keep insurance giant AIG out of insolvency.

Dow Jones industrial average fell 449.36 points to end the day at 10,609.66, despite a temporary bounce in mid-afternoon trading.

North of the border, the S&P/TSX composite index fell 349.30 points, finishing at 11,877.69.

"Essentially, we saw lending freeze up in the United States after the AIG bailout by Washington," BNN's Michael Hainsworth told CTV Newsnet after the markets closed.

"The street said, 'Wait a minute - if a juggernaut of this size is capable of failing, who else is?' So the banks tightened up the lending restrictions, and that really ground both Bay Street and Wall Street to a halt."

Late Tuesday, the Federal Reserve in the U.S. announced it would provide an $85-billion loan to save American International Group Inc. from collapse in order to protect the broader market.

"People are scared to death," said Bill Stone, chief investment strategist for PNC Wealth Management. "Who would have imagined that AIG would have gotten into this position?"

The Fed warned the collapse of AIG could "lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance."

As part of the bailout, the U.S. government received a 79.9 per cent equity stake in AIG.

Earlier this week, nervous investors began bailing out of the market after Lehman Brothers filed for bankruptcy protection and Merrill Lynch agreed to be bought by the Bank of America.

Goldman Sachs Group Inc. and Morgan Stanley -- the two remaining Wall Street investment firms -- were being closely watched by investors Wednesday.

As stocks were being abandoned, some investors were buying gold as a hedge against rising risk Wednesday. The shift pushed the price of the December bullion contract by US$66.70 to $847 on commodities markets.

Overseas, Japan's Nikkei stock average jumped 1.2 per cent after AIG's rescue, but Hong Kong's Hang Seng index lost 3.6 per cent.

The FTSE 100 fell 249.7 points to 4,954.5, while Germany's DAX gave back 1.15 per cent and the French CAC-40 moved 1.6 per cent lower.

Meanwhile, Canada's Nortel Networks Corp. was the latest victim of the economic turbulence.

Suffering from "foreign exchange impact and certain product delivery delays" the company cut its revenue outlook to between two and four per cent less than last year. Shares fell $1.61 to $4.11, a new all time low.

With files from The Canadian Press