U.S. stocks dropped in a broad global sell-off on Tuesday as investors worried that Europe's banking problems could derail the economic recovery.

The S&P 500 briefly fell below February's intraday bottom of 1,044.50, reaching its lowest point since early November 2009. The index is down about 13 percent from its closing high in late April. Some traders said they were looking for a 20 percent drop from that recent peak, which is the definition of a bear market.

European markets were on edge after the Libor three-month dollar rate rose to the highest level since July as banks became more wary of lending to European institutions after the Spanish government's rescue of a local bank over the weekend. Rising Libor rates raise banks' funding costs.

The euro fell to an 8-1/2-year low against the yen and approached a 4-year low versus the dollar, while safe-haven U.S. Treasuries rallied.

As there continues to be uncertainty about a variety of macroeconomic issues, it's much easier to continue selling than to feel that we're getting close to an end that would justify a resumption of buying, said Michael James, senior trader at Wedbush Morgan in Los Angeles.

James described the tone of the selling as relentless.

Banks and industrial stocks were among the hardest hit, with Bank of America Corp down 2.2 percent at $15.06 and Caterpillar Inc off 2.9 percent at $57.53.

The Dow Jones industrial average <.DJI> was down 204.96 points, or 2.04 percent, at 9,861.61. The Standard & Poor's 500 Index <.SPX> was down 21.91 points, or 2.04 percent, at 1,052.15. The Nasdaq Composite Index <.IXIC> was down 45.50 points, or 2.06 percent, at 2,168.05.

Nearly all 30 Dow stocks were in negative territory while decliners outnumbered advancers on the New York Stock Exchange by a ratio of about 15 to one. On the Nasdaq, about eight stocks fell for every one that rose.

Earlier, the three major U.S. stock indexes had each fallen about 3 percent to session lows.

The CBOE Volatility Index <.VIX> or VIX, known as Wall Street's fear gauge, was up 4.2 percent at 39.92 in early afternoon trading.

Hours before Wall Street's opening bell, the mood darkened with North Korea's threats of military action against South Korea. Those tensions drove South Korean shares to a 15-week closing low as the government in Seoul convened an emergency session, rattling investors around the globe. The threats followed the sinking of a South Korean warship, allegedly by the North, in March.

Commodities also participated in the sell-off, with July crude futures sinking 2.7 percent to $68.31 a barrel. Chevron Corp fell 3.1 percent to $71.19 while fellow Dow component Exxon Mobil Corp lost 2.3 percent to $58.79.

Demand has been negatively impacted by what's going on overseas, said Andy Fitzpatrick, director of investments at Hinsdale Associates in Hinsdale Illinois.

In one bright spot, U.S. consumer confidence rose for the third straight month in May to the highest in more than two years. But that was countered by a report showing single-family home prices dropping in the first quarter on renewed price pressure as federal aid faded away.

In earnings news, Medtronic Inc slid 3.4 percent to $39.25 despite reporting fourth-quarter earnings that beat expectations.

On the upside, shoe retailer DSW Inc gained 4.4 percent to $28.47 after reporting first-quarter earnings that easily topped consensus.

(Reporting by Ryan Vlastelica; Editing by Jan Paschal)

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