US STOCKS-Wall St drops as economic, European worries weigh

* Philly Fed factory activity slumps in August

* Fed scrutinizing European banks' US units-report

* VIX jumps to 40 on Wall Street's nervousness

* Indexes off: Dow 3.5 pct, S&P 4 pct, Nasdaq 4.4 pct

* For up-to-the-minute market news see [STXNEWS/US] (Updates to afternoon)

By Caroline Valetkevitch

NEW YORK, Aug 18 (Reuters) - U.S. stocks sank on Thursday as data fueled worries the economy was weakening and bank shares tumbled on fears the European financial crisis could spread havoc to other parts of the world.

The losses extended a slide in stocks that began in late July, with the S&P 500 now off 15.7 percent from its April 29 highs, as economic worries both here and abroad have caused investors to exit risky assets.

Factory activity in the U.S. Mid-Atlantic region as surveyed by the Philadelphia Federal Reserve Bank plummeted in August, falling to the lowest level since March 2009. For details, see [ID:nN1E77H0E8]

Bank shares contributed to the market's slide. While a Federal Reserve official said the Fed scrutinizes U.S. banks and the American units of European banks equally, a Wall Street Journal report said regulators are questioning the U.S. units of Europe's lenders more closely. [ID:nL5E7JI0Q]

In the broad selloff, sectors associated with growth were also hit hard. Top drags on the Dow included shares of IBM , down 4.8 percent at $163.25 and United Technologies , down 5.3 percent at $68.21. On the Nasdaq, shares of Oracle fell 7.8 percent to $25.34.

"Europe is dealing with an escalating fiscal crisis," said Robert Van Batenburg, head of equity research at Louis Capital in New York.

"In the United States the momentum is slip-sliding. You've got a lot of corporations that also came out with very worrisome comments that by the end of the quarter things really started to slow down."

The Dow Jones industrial average <.DJI> was down 398.55 points, or 3.49 percent, at 11,011.66. The Standard & Poor's 500 Index <.SPX> was down 48.11 points, or 4.03 percent, at 1,145.78. The Nasdaq Composite Index <.IXIC> was down 110.18 points, or 4.39 percent, at 2,401.30.

As the Dow fell more than 520 points early in the session, U.S. Treasury debt prices soared and spot gold rallied

Traders were on the defensive, paying more for protection as U.S. stocks tumbled on disappointing economic data and renewed bank worries. The CBOE Volatility Index <.VIX>, Wall Street's favorite pulse of investor sentiment, rose 29.4 percent to 40.87.

"This jump in the VIX has caught people off guard and they are now scrambling for protection," said optionMonster analyst Chris McKhann. Although risk perceptions rose Thursday, Wall Street's "fear gauge" is still below the 15-month high set at the close of trading on Aug. 8.

Puts on the SPDR S&P Trust were active, with more than two trading for every call. The fund fell 3.8 percent to $115.01. In SPY options, the soon-to-expire August out-of-the money $110 puts were among the most popular as 77,566 contracts traded. The August $115 SPY strike was the busiest, with 178,500 contracts traded, Trade Alert data showed.

Among banks, Citigroup Inc was off 7.7 percent at $27.54 and Morgan Stanley was down 6.4 percent at $15.92.

Shares of luxury retailer Tiffany & Co dropped 7.4 percent to $59.52.

Economists at Morgan Stanley lowered the outlook for global growth and said the United States and euro zone are "dangerously close to recession." (Reporting by Caroline Valetkevitch, additional reporting by Doris Frankel; Editing by Kenneth Barry)