(Updates to midday, changes byline)

NEW YORK, Feb 28 (Reuters) - U.S. stocks tumbled on Thursday as worries about the economy grew following a weaker-than-expected reading on gross domestic product and a warning from Federal Reserve Chairman Ben Bernanke that there probably will be bank failures because of the housing slump.

Stocks opened lower after new data showing sluggish growth in the economy, measured by GDP in the fourth quarter of 2007, and an increase in claims for jobless benefits.

Bernanke, during the second day of his semiannual testimony before a congressional committee, said there may be some failures among smaller banks that invested heavily in real estate because the housing market’s severe problems may drain their capital. He added, however, that the U.S. banking system overall is in good shape with the biggest banks well capitalized. For details, see [ID:nN28573663]

The KBW Bank Index .BKX was down 3.3 percent, while the Standard & Poor's financials index .GSPF was down 3 percent. JPMorgan Chase & Co. JPM.N shares led the Dow's biggest decliners and weighed heavily on the S&P 500. JPMorgan Chase slid 3.7 percent to $42.75 after two brokerages cut their earnings estimates.

“I think this is a real issue,” said Joseph Battipaglia, market strategist at Stifel Nicolaus in Yardley, Pennsylvania, adding that there are large inventories of homes for sale in states like Florida, California, Arizona and Nevada. He noted that banks in those markets that kept the loans on their books and did not diversify their lending could be in trouble.

The Dow Jones industrial average .DJI was down 127.65 points, or 1.01 percent, at 12,566.63. The Standard & Poor's 500 Index .SPX was down 12.93 points, or 0.94 percent, at 1,367.09. The Nasdaq Composite Index .IXIC was down 22.13 points, or 0.94 percent, at 2,331.65.

Battipaglia said the possibility of bank failures has not been discussed much, noting that the stock market generally reacts to news that is not only perceived to be negative but adds a new element.

American International Group Inc AIG.N, the world's largest insurer, fell 3.2 percent to $50.60 on the New York Stock Exchange ahead of quarterly earnings, due after the closing bell.

Shares of residential mortgage lender Thornburg Mortgage Inc TMA.N plummeted 17.6 percent to $9.51 after the company said it faced margin calls on $2.9 billion of securities backed by below-prime loans. For details, see [ID:nN28542608].

Home builders’ shares slid after the disappointing GDP data and a report showing a jump in jobless benefit claims in the latest week, which pointed to the widening impact of the U.S. housing downturn.

The Dow Jones U.S. home construction index .DJUSHB slid 6.3 percent. Shares of D.R. Horton Inc DHI.N, the largest U.S. home builder, slid 9 percent to $15.57 on the NYSE. Shares of Hovnanian Enterprises HOV.N, a builder of upscale homes, tumbled 6.8 percent to $10.09.

The latest reports on GDP and jobless claims revived uncertainty about companies’ profit outlook, which rely on investment by businesses and consumer spending. GDP measures total output of goods and services within U.S. borders. [ID:nN28549245]

In his congressional testimony, Bernanke also said that the central bank will do what is needed to shore up the sputtering economy.

Sprint Nextel Corp S.N dropped 10.4 percent to $8.02 on the NYSE after the U.S. cell-phone service company reported a quarterly loss of $29.45 billion and scrapped its dividend. For details, see [ID:nN28541756]

Among Nasdaq stocks, Microsoft Corp MSFT.O slid 1 percent to $27.99 and ranked as the heaviest weight on the Nasdaq 100 .NDX index. Bear Stearns cut its estimates for Microsoft's GAAP earnings per share for both the third quarter and fiscal 2008 after the European Commission levied a record fine against the company for failure to comply with antitrust sanctions. [ID:nBNG81878] (Editing by Jan Paschal)