* U.S. stocks pare gains, euro at break-even on ECB speculation

* ECB stops funding operations for some Greek banks-sources

* Encouraging U.S. economic data initially lift U.S. stocks

* Bonds pare losses on ECB news, oil remains lower

By Herbert Lash

NEW YORK, May 16 (Reuters) - U.S. stocks gained on Wednesday on encouraging U.S. housing and industrial production data but the euro faltered and government debt pared losses as uncertainty over Greece's future in the euro zone kept investors on the defensive.

The European Central Bank has stopped funding operations for some Greek banks, euro zone central bank sources told Reuters, adding to concerns that Greece's financial difficulties could wreak havoc in Europe and elsewhere.

The ECB declined to comment. But the Reuters report highlights the weak state of the banking sector in Greece, where Greeks are withdrawing money from banks out of fear their country may leave the euro zone.

One person familiar with the matter said four Greek banks' capital was so depleted they were operating with negative equity capital, according to the report. It was unclear exactly how many banks were affected.

The euro traded near break-even and banks dragged down Europe's top shares to close lower in choppy trade on worries over the stability of the euro zone.

"People are waiting to see what will happen with Europe; the line in the sand for taking some kind of action is getting closer," said Reed Choate, portfolio manager at Neville, Rodie & Shaw in New York.

Choate said efforts by German Chancellor Angela Merkel and new French President Francois Hollande to quell talk of a possible Greek exit from the euro zone were positive, but the reported withdrawal of ECB funding was weighing on markets.

The Dow Jones industrial average was up 10.79 points, or 0.09 percent, at 12,642.79. The Standard & Poor's 500 Index was up 0.27 points, or 0.02 percent, at 1,330.93. The Nasdaq Composite Index was down 2.03 points, or 0.07 percent, at 2,891.73.

The FTSEurofirst index of top European shares closed down 0.5 percent at 992.81.

MSCI's all-country world equity index was down 0.7 percent to 305.57.

U.S. stocks pared early gains on data that showed U.S. industrial production posted its fastest growth in over a year in April and a surge in groundbreaking for new homes suggested a rebound in U.S. housing was gaining some traction.

The twin data points bolstered investor sentiment that has been heavily hit by fears Greece will depart the euro zone.

"Because the focus has been so much on Greece and on the risk-on, risk-off trade, the economic data is taking a little bit of a back seat here," said John Canavan, market analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Germany wants to stabilize Greece within the euro zone, but Athens must stick to its agreements with international lenders, a German government spokesman said on We dnesday.

Bund futures fell to 143.25, and benchmark 10-year U.S. Treasury notes pared losses but were still down 3/32 in price to yield 1.78 percent.

Government debt has safe-haven appeal. When investors become jittery, prices rise.

The euro was up 0. 02 percent at $1.2733. The dollar rose 0.1 percent to 81.301, its highest in four months against a basket of currencies.

Oil prices pared losses but remained lower, their decline accentuated by a surprise build in U.S. crude inventories.

Brent crude was down 57 cents at $111.67 a barrel and U.S. oil traded down 95 cents $93.03 a barrel.