"We're seeing some selling ahead of the Fed, and we're selling on lack of progress in Greece," said Adam Sarhan, CEO of Sarhan Capital.
"The global economy remains weak. If the Greece domino falls, that could adversely affect (or) derail the global recovery," he said. "With rates at zero and Greece in the euro the economy's barely growing."
The German DAX closed 1.89 percent lower, while the Greek ATHEX Composite briefly fell more than 5 percent as regional bank stocks sold off. Greek 10-year bond yields gained about 4 percent after earlier spiking more than 7 percent.
Athens and its creditors failed to come to a deal over the weekend because Athens did not accept demands for deeper reforms of pensions, value-added tax (VAT) and of its administration, labor markets and industry, Reuters said. The European Commission said on Monday that Greece's creditors have made substantial concessions, and Germany's EU commissioner said the time had come to prepare for a "state of emergency".
Read MoreGreece on 'brink of disaster,' calls emergency meeting
European Central Bank President Mario Draghi also said on Monday that the ECB would continue approving emergency funding for Greek banks as long as they have enough cash and collateral to operate. He added "the ball lies squarely in the camp of the Greek government to take the necessary steps."
Last week, the International Monetary Fund said "major differences" remained and its team left Brussels, where negotiations were held.
"There's just a lot of uncertainty we just don't know how markets would play out were Greece to default," said Ben Garber, capital markets economist at Moody's Analytics. "It's best to trade cautiously."
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He said the bond market indicated some flight to safety on Greece and disappointing U.S. industrial production data.
Treasury yields recovered slightly in late morning trade, with the U.S. 10-year Treasury yield near 2.36 percent after hitting a low of 2.31 percent and the 2-year yield near 0.70 percent. The German 10-year bund yield gained to 0.82 percent after earlier dipping below 0.80 percent.
Outside of developments in the Greece debt talks, the key event for the week is the Federal Open Market Committee's two-day meeting, which begins on Tuesday and concludes Wednesday afternoon with a statement and press conference. Investors will scrutinize the release for indications on the timing of a short-term interest rate hike, for which consensus is September.
Read MoreThis would be scary enough to give Fed pause
Expectations for a September liftoff most likely mean Fed chair Janet "Yellen's press conference will be more hawkish than usual," said Peter Cardillo, chief market economist at Rockwell Global Capital. "That's going to weigh."
He said with fears of higher interest rates, uncertainty over Greece and quarterly options expiration on Friday, stocks should be volatile this week. Cardillo continues to watch 2,070 on the S&P 500 for support.