The U.S. House of Representatives rejected on Monday legislation designed to rescue the nation’s troubled financial system.

After three hours of debate on Capitol Hill, the shock vote of 228-205 against the measure sent the markets almost instantaneously into convulsions. The Dow Jones Industrial Average plunged 700 points - one of its biggest drops ever. The panic extended to global markets. Brazil’s Sao Paulo stock market plunged 10% and suspended operations. Canada’s S&P/TSX slid 7.1% and Mexico’s Bolsa tumbled 6.2%. Worldwide financial markets had slumped even before the House vote; shares in Hong Kong closed down 4% and in Paris and London they were down 3%.

The rejection of the measure came as turmoil in financial markets widened, prompting the Federal Reserve to inject new capital in response to continued strains in short-term funding. In terms of Foreign Exchange Swap Lines - the Federal Open Market Committee authorized a $330 billion expansion of currency swap arrangements, which allows the world’s central banks to increase the amount of money they can provide in their home markets, effectively injecting more money at the crisis. The Fed was also forced Monday to arrange the sale of Wachovia (WB) to Citigroup (C).

The NYT described the bill as a catastrophic political defeat for President Bush, who had put the full weight of the White House behind the measure. Bush had urged lawmakers to pass the bailout package quickly, and had lobbied wavering Republicans in intensely personal telephone calls saying it was needed to keep the financial crisis from spreading.

The House vote came after a weekend of tough negotiations produced a tentative agreement that Congressional leaders said was greatly strengthened by new taxpayer safeguards.

“The legislation has failed,” Speaker Pelosi said at a news conference after the vote. “The crisis has not gone away. We must continue to work in a bipartisan manner.”

Secretary Paulson speaking from the White House after holding talks with President Bush said the bailout bill was much too important to simply let it fail, and that all the parties need to work as quickly as possible in order to get something done.

Mr. Paulson promised to work with Congressional leaders to find a way to pass a comprehensive plan to stabilize the financial system. He concluded by saying that the banking system was holding up very well despite pressures.

U.S. presidential candidate Barack Obama expressed his confidence on Monday that Congress would ultimately pass the proposed $700 billion financial plan, despite its initial rejection by the House of Representatives.

“I’m confident that we’re going to get there. It’s going to be a little rocky,” said Obama, who added that “things are never smooth in Congress.” (Reuters)