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Dow down 160 points, S&P off 2%, as budget stalemate weighs

Stocks finished sharply lower for a second day on Tuesday, with major averages hitting one-month lows, as investors digested President Obama's call on Congressional Republicans to approve a budget and end the government shutdown.

The Dow Jones Industrial Average dropped 159 points, or 1 percent, dragged by Visa and IBM. The Dow has tumbled nearly 6 percent since hitting a record high of 15,709.58 on Sept. 18.

The S&P 500 and the Nasdaq also finished near session lows, with the Nasdaq down 2 percent. The Dow and S&P 500 are down for the 11th time in the last 14 trading sessions.

The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, jumped above 20. The index has surged nearly 23 percent in October alone.

Most key S&P sectors dropped, dragged by telecoms and materials, while utilities held modest gains.

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In a press conference, President Obama said he has yet to see serious proposals from the Republicans that would allow both sides to resolve their core differences.

"So my suggestion to the Speaker has been and will continue to be: 'Let's stop the excuses, let's take a vote in the House, and let's end this shutdown right now'...There are enough reasonable Democrats and Republicans in the house who are willing to vote 'yes' on the budget that the Senate had already passed."

(Read more:Art Cashin: Why I'm a 'little anxious' now)

"Investors seem to be adding a bit of risk premium in the market because you don't know how this is going to play out—you could actually see the government default," said Paul Zemsky, CIO of multi-asset strategies at ING U.S. Investment Management. "And investors also seem to be adjusting to what the true economic impact will be from the shutdown – it could be anywhere between 0.2 percent and 0.4 percent on GDP per month."

Without an increase to the $16.7 trillion debt limit, the Treasury will lack the funds to pay its debts from late October/early November onward.

(Read more: No way US would allow debt default? Don't bet on it)

"It's not a high probability event (that the government will default on its debt) but you can't say it's zero anymore," said Zemsky. "But [if it does happen,] everyone's expecting it to be a short default. At the same time, it will erode confidence in the U.S. Treasury market."

Earlier, House Speaker John Boehner said he is willing to negotiate budget issues with President Obama without any conditions. "I'm not drawing any lines in the sand," he told reporters.

Shortly after the press conference, Boehner's spokesman said Obama called Boehner and reiterated that he would not negotiate on the government funding bill or debt ceiling increase.

(Read more: What is the 'debt ceiling,' anyway? We explain)

In the absence of hard economic data due to the shutdown, investors will focus on the upcoming third-quarter earnings season.

Former Dow component Alcoa and KFC parent company Yum Brands were slated to post quarterly results after the market close.

Meanwhile, two Federal Reserve officials said that they had wanted the central bank to begin scaling back back asset purchases during their meeting in September. Cleveland Fed President Sandra Pianalto said the improvement in labor market conditions since the Fed launched the program in the fall of 2012 seemed "substantial enough" to support a tapering of the stimulus package.

And at a separate event, Philadelphia Fed president Charles Plosser said economic conditions are now in place that should allow the Fed to quickly end its bond purchasing program.

The Treasury auctioned $30 billion in 3-year notes at a high yield of 0.710 percent. The bid-to-cover ratio, an indicator of demand, was 3.05, versus a recent average of 3.35. Benchmark 10-year notes were last down 3/32 in price to yield 2.643 percent. The yields have struggled to break below resistance at around 2.60 percent.

The auction was the first of a $64-billion supply this week. The Treasury will sell $21 billion in 10-year notes on Wednesday and $13 billion of 30-year bonds on Thursday.

Asian shares pared most of their early losses on Tuesday, as mainland Chinese and Hong Kong markets climbed in the first day of trade after the "Golden Week" public holiday.

Shares were lower in Europe meanwhile, with British retailers trading down after the British Retail Consortium reported weaker sales growth. But technology stocks were higher, boosted by a bounce in shares of French company Alcatel-Lucent, which announced the latest part of its cost-cutting plan.