* Banks slide on worries about nationwide mortgage probe * Initial jobless claims rise more than expected * Yahoo shares climb, source says PE interest in buying * Dow off 0.3 pct, S&P down 0.6 pct, Nasdaq off 0.4 pct (Updates to midday, changes byline)
By Ryan Vlastelica
NEW YORK, Oct 14 (Reuters) - Bank shares led the Dow and the S&P 500 lower on Thursday, reflecting investors' fears of how a nationwide probe into the mortgage industry's foreclosure practices might affect earnings.
JPMorgan Chase & Co and Bank of America ranked as the two heaviest weights on the Dow, while Bank of America alone was the S&P 500's fifth-biggest percentage decliner. An S&P index of financial services shares slid 2.3 percent.
But the U.S. dollar's slide limited stocks' losses.
New claims for jobless benefits unexpectedly rose 13,000 in the latest week. Though this data was yet another reminder that the labor market remains weak, it reinforced the view that the Federal Reserve will pump more money into the sluggish economy in another round of quantitative easing.
The KBW bank index tumbled 3.6 percent on increasing worries that a joint investigation into home foreclosure procedures by attorneys general from all 50 U.S. states would cause uncertainty and threaten the recovery of the fragile housing market.
"Today is really about banks and the jobless claims on one hand, and the dollar on the other," said Jeffrey Friedman, senior market strategist at Lind-Waldock in Chicago.
"The foreclosure issue will weigh on us until we see a bottoming in the housing market, and right now, we don't know what kind of financial obligations are possible for banks."
Every component of the KBW bank index was in negative territory. Bank of America Corp lost 5.8 percent to $12.52. JPMorgan Chase & Co slid 3.1 percent to $38.62.
The Dow Jones industrial average dropped 36.32 points, or 0.33 percent, to 11,059.76. The Standard & Poor's 500 Index shed 6.89 points, or 0.58 percent, to 1,171.21. The Nasdaq Composite Index slipped 10.06 points, or 0.41 percent, to 2,431.17.
The stock market benefited as the dollar fell to a 2010 low against a basket of major currencies after Singapore expanded its currency trading band, driving the Singapore dollar to a record high. The prospect of additional Fed stimulus has created an inverse correlation between the dollar and stocks, with a drop in the greenback sparking a move into equities.
After an 11.7 percent rise in the benchmark S&P 500 since Sept. 1, short-term momentum indicators have begun to show overbought conditions.
The rally has also brought out some broad bearish bets in the options market. Trading in index ETFs was above normal Wednesday, with about 3.88 million puts and 2.90 million calls changing hands across all products.
Google Inc shares slipped 0.5 percent to $540.47 and helped pressure the Nasdaq as investors await the release of Google's earnings after the closing bell. Traders in Google options looked they were pricing in a potential post-earnings move of just over 4 percent in the stock's price, which is down from the average swing of 6 percent over the past four quarters.
But a bright spot was provided by Yahoo Inc, up 3.4 at $15.77 after a source said that several private equity firms had approached Internet and media companies, including News Corp and AOL Inc, to gauge their interest in buying the company.
Safeway Inc rose 1 percent to $21.54 after the grocery store operator reported adjusted third-quarter earnings that beat expectations.
But shares of industrial distributor WW Grainger Inc shed 3.1 percent to $121.40 after it forecast a moderation in its fourth-quarter organic revenue growth. (Reporting by Ryan Vlastelica; Additional reporting by Doris Frankel; Editing by Jan Paschal)