* Global stocks sink as AIG, HSBC unnerve investors
* Financial sector sentiment worsens on huge AIG loss
* Dollar index hits 3-yr high as investors seek safety
* Oil drops 10 pct, government debt up in safe haven bid (Adds close of European markets)
By Herbert Lash
NEW YORK, March 2 (Reuters) - Global stocks fell sharply on Monday after a record $61.7 billion quarterly loss at AIG and an $18.3 billion capital request at HSBC slammed world markets, sending the dollar to 3-year highs and investors fleeing to the safety of government debt.
Insurer American International Group's quarterly loss, the largest in U.S. corporate history, renewed concerns about the health of the financial sector. The worldwide sell-off of risky assets came as oil prices dropped as much as 11 percent.
"AIG again raised the specter of 'What's the bottom on the banking and finance sector?'" said Peter Jankovskis, director of research at OakBrook Investments LLC in Lisle, Illinois.
Warren Simpson, managing director at Stephens Capital Management in Little Rock, Arkansas said, "AIG is the stench that has just overtaken the market, no doubt about it."
European shares closed down 5 percent after Asian stocks slid about 4 percent. U.S. stocks fell more than 3 percent as the Dow slid under the 7,000 mark for the the first time since October 1997 and the S&P 500 was poised to slide below 700.
Investors also were unnerved by HSBC, Europe's biggest bank, which launched a 12.5 billion pound rights issue to shore up its balance sheet, and comments by investor Warren Buffett, who said "the economy will be in shambles throughout 2009 ... and probably well beyond."
Shares of AIG, which lost $99.29 billion for all of 2008, fell 14 percent to 48 cents a share as the company agreed to a new bailout. Shares of HSBC fell 18.8 percent. FTSEurofirst 300 ended a whisker away from its lifetime low of 681.17 hit in March 2003.
Global stocks, as measured by MSCI's all-country world equity index, fell more than 4 percent to almost a six-year low.
All 30 components of the Dow were in the red as more than one out of every six stocks on the New York Stock Exchange fell to new 52-week lows. Declining shares outnumbered advancing shares by more than 11 to 1.
Analysts said the news reaffirmed suspicion that more turmoil lies ahead, spurring investors to sell stocks for safer, dollar-denominated alternatives such as Treasuries.
The benchmark 10-year U.S. Treasury note rose 30/32 in price to yield at 2.91 percent, while the yield on the the 10-year Bund fell as low as 3.014 percent.
"Market conditions are extremely difficult. Quite a lot of investors have gone into the survival mode, just like the companies. Capital preservation is the key at the moment," said Philippe Gijsels, senior equity strategist at Fortis Bank in Brussels.
About 1 p.m., the Dow Jones industrial average was down 239.90 points, or 3.40 percent, at 6,823.03. The Standard & Poor's 500 Index was down 27.64 points, or 3.76 percent, at 707.45. The Nasdaq Composite Index was down 41.82 points, or 3.04 percent, at 1,336.02.
Energy stocks fell after crude prices tumbled below $40 a barrel at one point as a deteriorating world economy threatened to further cut fuel consumption.
In Europe, shares of BP fell 5.7 percent and Royal Dutch Shell fell 6.2 percent, taking the most points off of Britain's top index, the FTSE 100, after HSBC.
In U.S. markets, investors dumped shares of large manufacturers, with 3M Co off 5 percent Caterpillar Inc shares fell 9 percent.
European Union leaders' rejection of a mass bailout for Eastern Europe pushed the euro below $1.26, as did a survey showing euro zone manufacturers had their worst month in 12 years. For details, see [ID:nL1547427] and [ID:nL2213083].
The euro fell 0.76 percent at $1.2572 as the dollar rose against a basket of major currencies, with the U.S. Dollar Index up 0.79 percent at 88.862.
Against the yen, the dollar fell 0.27 percent at 97.26.
U.S. light sweet crude oil fell $4.88 to $39.88 a barrel.
Gold dropped after rising earlier. Heavy losses in equity markets triggered profit-taking after the metal failed to climb further above $1,000 an ounce last week.
Spot gold prices fell 60 cents to $943.55 an ounce. (Reporting by Chuck Mikolajczak, Steven C. Johnson and John Parry in New York and Joanne Frearson, Christopher Johnson and Jan Harvey in London; writing by Herbert Lash; Editing by Kenneth Barry)