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Small-cap stocks turned a sleepy morning erosion into a full-blown afternoon debacle, as worries about the financial system renewed concerns about any near-term economic recovery and sparked money flow away from equities. The Russell 2000 (NYSE:IWM) closed down 14.23, or 2%, at 696.11.

The trigger for today’s sell-off appeared to be news that FDIC regulators seized two small banks that failed over the weekend, and sold them off to Mutual Omaha Bank. The immediate beneficiary of these systemic financial worries was the Treasury market, with bond and notes lifted by safe-haven flows out of stocks. The yield on the benchmark 10-year note tumbled over 2% as cash 10s rallied.

With nearly one-fourth of the S&P 500 reporting earnings this week, the early-week focus was expected to be squarely on the profit picture, giving the market time to shift into “macro-economic” gear later this week ahead of Friday’s big employment release. However, key earnings numbers were mixed today, and failed to generate enough of a positive story to counter the bank failure news. It should be noted that volume in most financial instruments — stocks, bonds and currencies combined — was light, which suggests some uneven positioning as investors either wait for some of this week’s heavy economic calendar to play out, or as they hold out for more convincing signs of a turn in the earnings news.

Looking ahead to Tuesday’s session, the market gets the first taste of economic data this week, first with the Case Shiller Home Price Index at 9:00 a.m. ET, then from Consumer Confidence data at 10:00. The Case Shiller data is somewhat dated, but the confidence report is for the July time frame.

Crude oil prices were modestly higher throughout the session, which also played into investor concerns about the growth and inflation outlook heading toward all these key economic reports this week. Crude oil futures gained about $1.50 dollars a barrel today, or about 1.2%, pushing close to $125 by the end of the U.S. trading session. Attacks by Nigerian rebels on pipelines lifted energy prices, but concern . . .

Small-cap stocks edged lower Monday, pulled down by nagging concerns linked to the ongoing credit crunch, which weigh on small-cap financial institutions and by a record high crude oil prices. The Russell 2000 (NYSE:IWM) dipped 8.48, or 1.21%, to 689.66, generating the lowest daily close for the Russell since April 15.

Despite 10-week closing lows, price action today in small caps was relatively sleepy, with the Russell 2000 contained to an eight-handle range, compared with a 20-handle range last Thursday.

When the market opened this morning, equities were alarmed at a new record high in crude oil prices, which rose above $143 dollars a barrel overnight amid tensions between Israel and Iraq. However, crude oil was unable to sustain those new highs and actually dipped briefly into negative territory in the afternoon, leaving a potential bearish topping signal on daily charts that allowed stock market investors a little breathing room. Also on the commodities scene, gold prices pulled back today, and corn futures plunged down the daily trading limit.

Earlier this morning, the Chicago PMI headline figure came in at 49.6, which was a much better showing than the median forecast for a reading of 48. Still, the number was below the 50 contraction line for the fifth consecutive month, which underscores a soft picture in the Midwest manufacturing scene. The Chicago data was just the first of several manufacturing-oriented reports this week, but the big economic report comes Thursday morning with the monthly employment release.

For the first time in quite awhile, the Dow rallied in the face of declines in small-cap stocks. The Dow has been in collapse mode of late, sinking to 2-year lows even though the Russell 2000 was still well above the March 2008 bottom. The Dow benefited today from gains in a couple of oil company shares and from a rise in Wal-Mart (NYSE:WMT), which stands to hold up better than high-end retailers . . .