IMPEACH BUSH

WASHINGTON -- The House of Representatives defeated the White House's historic $700 billion financial-rescue package -- a stunning turn of events that sent the stock market into a tailspin and added to concerns that the U.S. faces a prolonged recession if the legislation isn't revived.

The Dow Jones Industrial Average sustained its biggest point drop in history and its biggest closing decline since the day the markets re-opened after the Sept. 11, 2001, terrorist attacks. The Dow, which had opened sharply lower on fears of more possible bank failures, finished the day down 7%, with a 777.68 point drop to 10365.45. Losses to shares on the broader Dow Jones Wilshire 5000 index amounted, on paper, to $1.2 trillion -- eclipsing the size of the proposed bailout package. The Nasdaq Stock Market finished down 9.1%.

The widely watched VIX index, a measure of market volatility often called "the fear index," closed at its highest levels in its 28-year history. In early trading in Asia Tuesday, Japan's Nikkei was off 4.5%, and other markets also were down.

The 228-205 vote, which defied a full-court press from the president and the Treasury secretary, marked a dark moment in a month that has shaken the financial system to its core and forced the government to take a host of ad hoc measures to shore up confidence. Earlier Monday, U.S. authorities helped arrange the sale of Wachovia Corp. to Citigroup Inc., while the Federal Reserve joined other central banks in injecting more funds into credit markets.

The bailout was designed in part to get financial institutions lending again by ridding the market of the toxic mortgage-backed securities and other holdings that lenders fear could cause borrowers to default. If credit markets continue to seize, the impact on businesses and consumers could be widespread. Access to loans would be reduced, crimping spending and investment. Economists said the credit crunch could lead to increased layoffs in the U.S. and prompt a hefty rate cut from the Federal Reserve.

"The legislation may have failed," said House Speaker Nancy Pelosi, a California Democrat. "The crisis is still with us."

The bill's failure puts the Treasury Department in a bind. Officials there considered the rescue plan as a last-ditch effort to come up with a systemic approach to tackling the financial crisis. The Treasury can take some incremental steps, such as expanding a program to buy mortgage-backed securities issued by mortgage giants Fannie Mae and Freddie Mac, or using other administrative tools. But none of these measures would be as comprehensive in tackling the problems at the heart of the financial system.

In lieu of legislation, Treasury is likely to revert to addressing problems institution by institution, according to a person familiar with the matter, while waiting to see whether Congress will revisit Monday's vote. The government is likely to continue trying to extinguish fires by lending money to troubled institutions, aiming to prevent failures that could ripple through the financial sector. That could result in the government taking on the same toxic assets, but by a different route. The Federal Insurance Deposit Corp., which resolves failed banks, could also play a greater role.

"Our tool kit is substantial but insufficient," Treasury Secretary Henry Paulson said after the bill's failure.

Ever since Mr. Paulson unveiled the proposal two weekends ago, the rescue package had helped buoy financial markets. But it also sparked deep unease among lawmakers over what would be an unprecedented government intervention in the private sector.

The bill's failure marks a stinging defeat for the nation's political leadership. Both Republican and Democratic leaders in Congress and the White House had crafted an agreement over the weekend that was supposed to appease these simmering tensions.

But Monday's vote split both parties, whose members had been barraged all week with angry messages from constituents who opposed the bill. Among Democrats, 140 supported the bill and 95 voted against. Support among Republicans, who had revolted against an earlier iteration of the bill last week, was at the low end of what was expected by the House Republican leadership, with 65 in favor and 133 against. One Republican, retiring Rep. Jerry Weller of Illinois, did not vote.

In voting against the bill, conservatives who opposed government intervention were joined by many Democrats facing tight races in November. Other no votes were cast by House members from poorer districts, including members of the Congressional Black and Hispanic caucuses.

Of the 18 Democratic and Republican incumbents in close races -- classified "tossup" contests by the Cook Political Report -- just three voted for the bill. All six freshmen Democrats in tossup races voted against the bill.

Congressional leaders said they intended to go back to work on the bill, with a new vote possibly late in the week after the Jewish holiday of Rosh Hashanah, which began at sundown Monday and runs through Wednesday night.

'Calm Down and Relax'

But complex election-year politics make the outcome hard to predict. "We are going to continue to work," said Rep. Steny Hoyer, House majority leader. John Boehner, his Republican counterpart, suggested there would be further efforts to change the bill. "We need everybody to calm down and relax and get back to work," he said.

Democrats face a choice whether to continue work on a bipartisan bill or try to pass the bill with a majority of their party alone. That would likely mean reviving points that Republicans oppose, including an economic-stimulus package and a controversial provision that would allow bankruptcy-court judges to alter the terms of mortgages. For now, House Speaker Pelosi is committed to a "bipartisan bill," a Democratic leadership aide said.

Following the bill's failure, both parties embarked on a round of bitter finger-pointing. Congressional Republicans cited a speech by Ms. Pelosi on the House floor that blamed the economic crisis on years of Republican economic policies, including deregulation. "For too long this government, eight years, has followed a right-wing ideology of anything goes, no supervision, no discipline, no regulation," Rep. Pelosi said. "It has created not jobs, not capital; it has created chaos."

Rep. Eric Cantor of Virginia held up a copy of the remarks at a press conference held by Republican leaders and said Rep. Pelosi's "failure to listen and failure to lead" was to blame for some Republican defections.

Rep. Roy Blunt, the minority whip, said that "a couple" of Republicans said they were offended by the speaker and changed their minds. But he said those lawmakers were already wavering.

Rep. David Obey, a Wisconsin Democrat who stood watching the Republicans criticize Rep. Pelosi, called their remarks "ridiculous." He said the Republicans were jockeying for position before upcoming leadership elections. "The President wouldn't have gotten to first base without the cooperation of the Democratic leadership," Rep. Obey said. "Evidently some of these guys would rather lose the economy than lose the election."

The measure would have given Treasury a $700 billion line of credit and wide authority to buy the mortgages, securities and financial assets that are undermining market confidence.

The Bush administration had hoped the plan would stabilize financial markets as bad assets are pulled under the government's wing. Under the legislation, troubled banks and investment firms would qualify for government assistance, as would pension plans, local governments and small banks.

In many ways, the plan was star-crossed from the beginning. Treasury's initial two-and-a-half page proposal was ridiculed by lawmakers for granting the administration virtually unfettered power to spend the money as it saw fit. During a week of negotiations, the bill swelled with extra conditions and protections for taxpayers.

On Thursday, President George W. Bush convened a White House summit in a bid to unite leaders of both parties, as well as presidential candidates Sens. Barack Obama and John McCain, behind the proposal. But conservative House Republicans, encouraged by the return to Washington of Sen. McCain, demanded additions to make the bill more "free market." The dissention derailed an already contentious summit.

The administration, meanwhile, failed to get a handle on the politics of the package. It was quickly dubbed a "Wall Street bailout." Although President Bush talked repeatedly about the impact of restricted lending on small businesses, jobs and savings, a populist uproar continued to tag the bill as a rescue plan for the financial whizzes who caused the financial mess. In addition, lawmakers were frustrated with the terse answers from Treasury about how exactly the money would be spent.

"I guess [Democrats] saw the same problems we did and they didn't want to go home and explain this thing," said Rep. Scott Garrett, a Republican from New Jersey who voted against the bill.

When the deal was brokered, Democrats said they planned to come up with 120 votes. Party leaders drew votes from the New York delegation, which tends to be sensitive to stock-market concerns, and gained support from moderate Democrats.

On the Republican side, Rep. Blunt, the minority whip, told Majority Whip James Clyburn that he expected 70 votes. If the "energy on the floor" took hold, Rep. Blunt said, he might be able to deliver as many as 80, according to a Democratic aide. Old-guard Republicans, such as Reps. Jim McCrery of Louisiana, David Dreier of California and Spencer Bachus of Alabama, were lined up behind the administration's effort.

Though the vote was expected to be tight, few on Monday morning foresaw the possibility of defeat. President Bush and Treasury Secretary Paulson called numerous lawmakers, including Rep. Randy Neugebauer, a Texas Republican, trying to whip up last-minute support.

"Secretary Paulson said, 'We need you, and is there any question I can answer that is keeping you from voting yes,'" Rep. Neugebauer said. "I asked all the questions. I just didn't like the answers."

Shortly after noon, less than an hour before the voting began, White House spokesman Tony Fratto predicted the votes would be there. He said that Vice President Dick Cheney and senior aides, including chief of staff Josh Bolten and counselor Ed Gillespie, were also making calls. "I think everyone with a phone is calling to see if we can shore up a member who may be skeptical of the proposal," Mr. Fratto said.

Early in the afternoon, as the vote got under way, the stock market was jittery. Investors were rattled by the weekend collapse of Dutch-Belgian bank Fortis NV and the sale of Wachovia to Citigroup. As the 15-minute window for House members to cast their vote opened shortly before 1:30 p.m., the Dow Jones Industrial Average was down by more than 250 points.

By about 1:40 p.m. the "nay" votes were slightly ahead. On trading floors, traders stood in semicircles around televisions, watching the slowly changing tally.

Lurched Downward

When the voting clock hit zero at about 1:43 p.m. with the "no" votes in the lead, the stock market lurched downward. In the span of one minute the Dow lost 100 points, extending its loss to 414 points. By 1:45 p.m., the loss reached 580 points; two minutes later, it had widened to 673 points.

Top Democrats argued about whether or not to keep the vote open to whip up enough votes, but decided against it.

Senate Democrats were in a caucus meeting when a staffer brought Senate Majority Leader Harry Reid of Nevada a note with the vote tally. Almost immediately, lawmakers began handing their BlackBerrys to each other and sharing the news, according to a person present.

Democrats, dismissing complaints about Rep. Pelosi's speech, immediately blamed Republicans for failing to deliver enough votes on their end. "Because their feelings were hurt, they're deciding to punish the country," said House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat. "We think they are covering up the embarrassment of not having the votes."

Amid the acrimony, Rep. Blunt called Reps. Hoyer and Frank, as well as several senators, to say he was ready to find a way forward. Mr. Blunt said he plans to reach out to lawmakers who voted no. "You don't have to find very many," he said. "But you can't do things that drive 'yes' votes...away."

House Democrats met late Monday afternoon to decide those issues. Negotiations weren't expected to resume immediately. The House reconvenes on Thursday.

—Deborah Solomon, Tom Lauricella and Easha Anand contributed to this article.

Write to Sarah Lueck at sarah.lueck@wsj.com, Damian Paletta at damian.paletta@wsj.com and Greg Hitt at greg.hitt@wsj.com