Stocks fell more than 1 percent on Friday as a possible debt default by a Dubai state-owned conglomerate increased investors' uncertainty about the financial system's strength.

U.S. stocks sold off broadly, sliding 2 percent or more at the opening, but selling was concentrated mainly in the financial and commodity-linked sectors as investors pared positions in areas of the market most sensitive to economic uncertainty.

But by midday, the flight to less risky assets seemed to be subsiding, helping the major U.S. stock indexes recover from intraday lows. The U.S. dollar, which had jumped sharply as investors looked for a safe haven, pared gains and commodity prices stabilized.

Fears of a contagion effect from Dubai appeared to be ebbing among investors as. European shares closed higher after a sharp sell-off in the previous session.

There were some big concerns overseas yesterday that you might see a mushrooming effect from the Dubai World credit problems. But at least so far in the U.S. markets, a lot of that has been shrugged off, said Michael James, senior trader at Wedbush Morgan, a regional investment bank in Los Angeles.

The Dow Jones industrial average <.DJI> dropped 140.12 points, or 1.34 percent, to 10,324.28. The Standard & Poor's 500 Index <.SPX> fell 17.16 points, or 1.55 percent, to 1,093.47. The Nasdaq Composite Index <.IXIC> lost 29.50 points, or 1.36 percent, to 2,146.55.

At its session low, the Dow touched 10,231.25 earlier in the day, when the S&P 500 fell as low as 1,083.74, and the Nasdaq dropped as low as 2,113.99.

On Wednesday, Dubai said it would ask creditors of state-owned Dubai World and Nakheel, the builder of its palm-shaped islands, for a standstill agreement as a first step toward restructuring billions of dollars of debt.

It was uncertain how much exposure U.S. banks have in Dubai. But influential bank analyst Richard Bove said in a note it does not appear that American banks have any major direct impact from this event.

Bank of America fell 2.2 percent to $15.60, while Citigroup tumbled 2.2 pct to $4.08. The two stocks were the most heavily traded on the New York Stock Exchange.

Commodity-linked stocks sold off sharply but stabilized after the U.S. dollar pared gains and helped lift commodity prices off their lows.

Even so, Dow component Alcoa Inc fell 2.2 percent to $12.71, while gold miner Newmont Mining Corp lost 2.3 percent to $53.66.

The U.S. dollar rose 0.3 percent against a basket of currencies <.DXY>, after earlier climbing around 1 percent. U.S. crude futures for January dropped $3.06, or nearly 4 percent, to $74.90 a barrel. Dow component Exxon Mobil Corp shares fell 2 percent to $74.96 on the New York Stock Exchange.

On Thursday, U.S. financial markets were closed for the Thanksgiving holiday in the United States.

But financial markets around the world shuddered, reflecting fears about the impact of a potential Dubai debt default.

Friday's U.S. stock trading session is abbreviated, with the market close set at 1 p.m. (1800 GMT).

(Reporting by Edward Krudy; Editing by Jan Paschal)

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