Sellers dominated the day as Europe delayed the release of bailout funds to Greece, raising more fears that Athens would default on its bonds.
Investors meanwhile dumped shares in Franco-Belgian bank Dexia on worries that it would founder on its holdings of European sovereign debt.
That forced French and Belgian regulators to step in and guarantee Dexia's depositors and creditors.
The still-unclear picture on how the eurozone would surmount its crisis sent London's FTSE-100 falling 2.58 per cent to 4,944.44 points. In Frankfurt, the DAX tumbled 2.98 per cent to 5,216.71 points and in Paris the CAC-40 shed 2.61 per cent to 2,850.55 points.
Elsewhere in Europe, Madrid lost 1.54 per cent, Lisbon 2.18 per cent, Milan 2.72 per cent, Amsterdam 2.02 per cent and Brussels 3.13 per cent.
Asian markets also tumbled, with Tokyo losing 1.05 per cent and Hong Kong 3.40 per cent.
The Greece impasse raised the prospect that holders of Greek debt, already expecting to take a 20 per cent "haircut" on its value, could instead find it written down more than 50 per cent if Athens cannot raise any more money and has to default.
Dexia, which holds significant sovereign debt on its asset books, became the first eurozone bank to stumble on those worries.
Meanwhile US Federal Reserve chairman Ben Bernanke boosted the selloff when he gave a glum picture of the US economy in testimony to Congress, and warned legislators that their enthusiasm for budget-cutting could further stall growth.
With that grim background US stocks fell more than two per cent in early trade. They bounced back to near-even, then plummeted again, with the Dow Jones Industrial Average index of blue chips off two per cent just 45 minutes before the close.
Analysts said the last-hour surge back into positive territory came from media reports that EU officials were studying how to protect banks holding the debt of Greece and other financially week eurozone governments if Athens defaults.
The Dow rocketed in the final minutes to end 1.44 per cent higher at 10,808.71; the broader S&P 500 jumped 2.25 per cent to 1,123.95, and the tech-heavy Nasdaq Composite added 2.95 per cent to 2,404.82.
Peter Cardillo of Rockwell Global Capital called it a "furious comeback" that showed how the market may have been oversold.
"This is a good sign, this could mean that temporarily, we've made a bottom here...I just think the market has exhausted itself on the downside."
Even so, Dexia's problems showed that the same issue will continue to overhang the markets.
"Investors are facing the real possibility that bank exposures to sovereign debt and an increasing shut down in interbank lending markets could trigger a new banking crisis," said Joshua Raymond, chief market strategist at City Index.
"Bank shares have seen high volatility which in itself is exacerbating investor fears and uncertainty over the crisis," he said.
"Dexia's problems stress the point that for eurozone leaders (that) the Greek crisis is less about Greece and more about the potential for it to spark a much more widespread banking and economic disaster," said Rabobank analyst Jane Foley.
The euro rebounded after hitting its lowest level against the dollar since January 13, $1.3146 dollar.
At 2100 GMT it was trading at $1.3338, compared to $1.3178 late Monday.
The euro meanwhile edged back up to 102.14 yen after having traded earlier at 100.76 yen, the lowest level since 2001.
The dollar was at 76.82 yen, up slightly from 76.59 yen Monday.
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