Talks on the 14-billion-dollar package, backed by Democrats and the White House, broke down after Senate Republicans stood fast to their demand that US wages be brought swiftly in line with those paid by foreign automakers.
"I dread looking at Wall Street tomorrow. It's not going to be a pleasant sight," Democratic Senate Majority Leader Harry Reid said, after Wall Street stocks took a dive anticipating the news.
Sounding alarm over the potential for fresh job cuts, Senate Democrats prepared to press the White House to free up funds from the 700-billion-dollar Wall Street bailout package for the car companies.
"Millions of Americans, not only the auto workers but people who sell cars, car dealerships, people who work on cars are going to be directly impacted and affected," Reid said.
"I would hope that the president who has worked so well with us the past few weeks on this legislation would now consider using the TARP money to help the auto industry and the workers of this country."
Reid was referring to funds included in the Troubled Asset Relief Program (TARP), the 700-billion dollar rescue package for financial firms agreed earlier this year. Democrats wanted a portion of the funds for the US auto bailout but President George W. Bush's administration refused.
The White House, which backed Democrats' proposal for the short-term auto rescue loans and the version that passed the House of Representatives Wednesday, said it was "disappointed" by the breakdown in talks.
"It is disappointing that Congress failed to act tonight," White House spokesman Scott Stanzel told AFP.
"We think the legislation we negotiated provided an opportunity to use funds already appropriated for automakers and presented the best chance to avoid a disorderly bankruptcy," Stanzel said.
"We will evaluate our options in light of the breakdown in Congress."
Republican Senator Bob Corker, who spearheaded the alternative proposal, attributed the breakdown to differences over employee compensation, and said that a union representative from the United Auto Workers was present for the talks.
"We are about three words -- three words -- away from a deal," he said.
Democrat Chris Dodd, chairman of the Senate banking committee, lamented the breakdown, particularly with the holidays approaching.
"We will leave here tonight and go home for the holiday recesses, but for the literally hundreds of thousands of people whose jobs depend upon this industry, this will not be a joyous season wondering whether or not their jobs, their livelihoods, their homes, their children's futures are at risk," Dodd said.
After warning it could run out of money within weeks, the largest US automaker General Motors acknowledged ahead of the vote that it was considering "all options," including bankruptcy, and had hired a team of legal advisers.
"The GM board of directors has discussed bankruptcy, but when it has done so has not concluded that it was a viable solution to the company's liquidity problems," the company said in a statement.
"The board is meeting frequently and monitoring the situation very closely and is committed to considering all options -- as is management -- and has engaged appropriate advisors for all contingencies."
The legislation would have provided GM and Chrysler bridge loans to operate until March 31, the date by which they must have crafted a restructuring plan that ensures their long-term survival while repaying government aid.
The bill also required the president to name a special designee, or "car czar," who would oversee the process.
Foes of the plan have said the automakers must simply bear the burden of bad business decisions and declare bankruptcy.
Earlier, Republican Senate Minority Leader Mitch McConnell openly broke with Bush, telling colleagues on the Senate floor that the bill was not "tough enough."
"We simply cannot ask the American taxpayer to subsidize failure," McConnell said.
As prospects for passage dimmed, US blue chips tumbled 195.85 points (2.24 percent) to 8,565.57 at the closing bell while the Nasdaq fell 57.60 points (3.68 percent) to 1,507.88.
After talks collapsed in the Senate, Asian stocks fell, with Tokyo stocks tumbling more than five percent in early afternoon trade, while Hong Kong was down 6.5 percent. The dollar slumped to below 90 yen for the first time since 1995.