By lunchtime in Sao Paulo, Brazil's leading Bovespa index was down 9.5 per cent on worries that the government would be unable to implement crucial cuts in public borrowing.
US banks and hedge funds have substantial exposure to Brazil and analysts fear that if the Brazilian economy falters, this could mean more chaos in world financial markets.
Jim O'Neill, head of global strategy at Goldman Sachs, said: "These developments do not set a good precedent."
The defeat of proposed social security reforms, which would have saved $2.2bn (pounds 1.4bn) next year, put the Brazilian real under new pressure. The Brazilian Central Bank was reported to be selling dollars in an attempt to prop up the currency.
All Latin American stock markets were hit by the developments in Brazil, as was Wall Street, where the Dow dipped below the 9,000 mark. Emerging debt markets also had a volatile session, with Brazilian dollar bonds down by as much as 4.5 per cent.
Ironically, the Congressional defeat coincided with the International Monetary Fund's (IMF) decision to release the first tranche - $5.3bn - of the country's $41.5bn rescue package. The deal, announced last month, was designed to prevent the emerging market chaos spreading to Latin America.