Still, stocks managed to rebound from the day's lows near the end of the session, and for the week, major averages still ended higher, with the S&P 500 gaining 1.2 percent.
Trading was volatile as confidence eroded in the prospect of a deal out of Washington, and in part due to quarterly expiration of options and futures contracts. The CBOE Volatility Indexor VIX, the market's favored anxiety measure, finished below its high of the day.
Republican House Speaker John Boehner failed to garner enough votes from even his own party to pass his "Plan B" tax bill late on Thursday. It was the latest setback in negotiations to avoid $600 billion in tax hikes and spending cuts that some say could tip the U.S. economy into recession.
"The failure with Plan B was disappointing, if not terribly surprising, but now there's a real lack of clarity about what will happen, and markets hate that," said Mike Hennessy, managing director of investments for Morgan Creek in Chapel Hill, North Carolina.
Herbalifedropped for an eighth straight session. Investor Bill Ackman recently ramped up his campaign against the company. The company skidded 19 percent to $27.27 and has lost more than 35 percent this week.
Plan B, which called for tax increases on those who earn $1 million or more a year, was not going to pass the Democratic-led Senate or win acceptance from the White House anyway. But it exposed the reality that it will be difficult to get Republican support for the more expansive tax increases that President Barack Obama has urged.
Still, the declines of less than 1 percent in the three major U.S. stock indexes suggest that investors do not believe the economy will be unduly damaged by the absence of a deal, said Mark Lehmann, president of JMP Securities, in San Francisco.
"You could have easily woken up today and seen the market down 300 or 400 points, and everyone would have said, 'That's telling you this is really dire,'" Lehmann said.
"I think if you get into mid-January and (the talks) keep going like this, you get worried, but I don't think we're going to get there."
Banking shares, which outperform during economic expansion and have led the market on signs of progress on resolving the fiscal impasse, led declines. Citigroup Incfell 1.6 percent to $39.49, while Bank of Americaslid 1.9 percent to $11.29. The KBW Banks indexlost 1.19 percent.
Volatility on Friday was exacerbated in part by "quadruple witching," the quarterly expiration of stock index futures and options, stock options and single stock futures contracts.
About 8.59 billion shares changed hands on major U.S. exchanges, more than the daily average of 6.47 billion daily in 2012, in part due to expiration.
The Dow Jones industrial averagedropped 120.72 points, or 0.91 percent, to 13,191.00. The Standard & Poor's 500 Indexfell 13.52 points, or 0.94 percent, to 1,430.17. The Nasdaq Composite Indexlost 29.38 points, or 0.96 percent, to 3,021.01.
"Amazingly, this sharp decline today may not actually change the technical picture much - unless the decline gets worse," said Larry McMillan, president of options research firm McMillan Analysis Corp, in a research note.
The day's round of data indicated the economy was surprisingly resilient in November; consumer spending rose by the most in three years and a gauge of business investment jumped.
But separate data showed consumer sentiment slumped in December. The S&P Retail Indexfell 1.2 percent.
U.S.-listed shares of Research in Motionsank 22.7 percent to $10.91 after the Canadian company, known as the BlackBerry maker, reported its first-ever decline in its subscriber numbers on Thursday alongside a new fee structure for its high-margin services segment.
(Additional reporting by Ryan Vlastelica and Leah Schnurr; Editing by Bernadette Baum, Jan Paschal and Nick Zieminski)