Sept. 16 (Bloomberg) -- European stocks fell for a second day, sending the Dow Jones Stoxx 600 Index to the lowest in three years, after the downgrade of American International Group Inc.'s credit rating increased turmoil in global debt markets.

UBS AG, which reported more than $43 billion of subprime- related losses and writedowns, fell 17 percent after the cost of borrowing in dollars overnight more than doubled as banks hoarded cash. HBOS Plc, Britain's biggest mortgage lender, lost 22 percent. Xstrata Plc, the world's fourth-largest copper producer, dropped 7.4 percent as commodity prices retreated on speculation that the seizure in financial markets will hurt the global economy.

``We're at the heart of the storm right now,'' said Roland Lescure, who manages the equivalent of $128 billion as chief investment officer of Groupama Asset Management in Paris. ``The downgrade of credit ratings is bad news.''

The Stoxx 600 sank 2.6 percent to 263.54, the lowest since May 19, 2005, bringing this year's decline to 28 percent. More than $16 trillion has been erased from global equities in 2008 as the biggest surge in mortgage defaults in at least three decades sparked $514 billion in credit losses and writedowns.

The cost of borrowing in dollars overnight soared 3.33 percentage points to 6.44 percent, its biggest jump and highest level since 2001, the British Bankers' Association said.

Risk Appetite

``Banks have adjusted their risk premiums,'' said Peter Jarvis, a London-based director of European equities at F&C Asset Management, which has about $200 billion. ``Until we see clarity in the financial systems and trust between banks, investors' risk appetite for asset classes such as equities is not going to improve.''

Traders increased bets the Federal Reserve will cut borrowing costs today. The odds of a quarter point reduction in rates rose to 90 percent, up from 68 percent yesterday.

National benchmark indexes fell in all of the 18 western European markets except Spain and Portugal. The U.K.'s FTSE 100 sank 3.4 percent. Germany's DAX lost 1.6 percent, while France's CAC 40 declined 2 percent.

The VStoxx index, which measures the cost of using options as insurance against losses on the Dow Jones Euro Stoxx 50 Index, surged 11 percent to 36.19, the highest since March.

The Stoxx 600 Banks Index dropped to a two-month low as concern about defaults rose, according to traders of credit- default swaps. In Europe, the Markit iTraxx Financial index of 25 banks and insurers rose 19 basis points to 146.5, the highest in six months, according to JPMorgan prices.

AIG

AIG, which sold Wall Street's largest firms and other investors protection on $441 billion of fixed-income assets, had its credit ratings downgraded by S&P and Moody's, threatening efforts to raise emergency funds to keep the company afloat. The biggest U.S. insurer fell 61 percent yesterday after failing to present a plan to raise capital and stave off credit downgrades, helping push the Standard & Poor's 500 Index to the steepest drop since the September 2001 terrorist attacks.

Washington Mutual Inc., the biggest U.S. savings and loan, had its credit rating cut to junk by S&P. Lehman Brothers Holdings Inc.'s bankruptcy yesterday fueled speculation credit- related losses will worsen.

UBS, the largest Swiss bank, plunged 17 percent to 16.64 francs. Natixis SA, France's fourth-biggest bank, slumped 16 percent to 2.50 euros.

HBOS, the U.K.'s biggest mortgage lender, tumbled 22 percent to 182 pence.

Barclays, Xstrata

Barclays Plc retreated 2.5 percent to 308 pence. The U.K.'s third-largest bank said today it's in talks to buy assets from bankrupt Lehman two days after abandoning plans to acquire the entire securities firm.

Xstrata slid 7.4 percent to 2,105 pence. Anglo American Plc, the world's fourth-biggest diversified mining company, fell 6.3 percent to 2,258 pence.

BG Group Plc, the U.K.'s third-biggest oil and natural-gas producer, slumped 6.1 percent to 1,029 pence. Total SA, Europe's largest oil refiner, lost 2.7 percent to 42.23 euros.

Copper dropped to a seven-month low in London. Lead, nickel, tin and zinc also fell.

Crude oil tumbled, dipping below $91 a barrel and taking its two-day decline to more than $10 on concern that turmoil on Wall Street may weaken the global economy and reduce demand. The contract for October delivery fell as much as 5.4 percent to $90.55 on the New York Mercantile Exchange.

Technology stocks dropped after Dell Inc., the second- biggest personal-computer maker, predicted ``further softening'' in demand this quarter.

STMicroelectronics NV, Europe's largest chipmaker, lost 1.7 percent to 8.57 euros. Infineon Technologies AG, the industry's second biggest, retreated 5.1 percent to 5.63 euros.

Customers showed ``continued conservatism'' in technology spending in the U.S. last quarter, which has spread to Western Europe and some Asian countries, Dell said, reiterating comments made last month.

To contact the reporter on this story: Adria Cimino in Paris at acimino1@bloomberg.net.

Last Updated: September 16, 2008 12:15 EDT