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By Lisa Lambert
WASHINGTON, April 13 (Reuters) - U.S. regulators failed fivebig banks on Wednesday, including JP Morgan and Wells Fargo, ontheir plans for a bankruptcy that would not rely on taxpayermoney, giving them until Oct. 1 to make amends or risksanctions.
The move officially starts a long regulatory chain thatcould end with breaking up the banks. Nearly a decade after thefinancial crisis, it underscored how the debate about banksbeing "too big to fail" continues to rage in Washington andexasperate on Wall Street.
Wednesday's announcement was the first time the two majorbanking regulators, the Federal Reserve and the Federal DepositInsurance Corporation, issued joint determinations flunkingbanks' plans, commonly called "living wills."
If the five, which also included Bank of America Corp, State Street Corp and Bank of New York MellonCorp., do not correct serious "deficiencies" in theirplans by October, they could face stricter regulations, likehigher capital requirements or limits on business activities,regulators said.
If the deficiencies persist for two years, then the bankswill have to divest their assets. They have until July 2017 toaddress more minor "shortcomings."
The requirement for a living will was part of the Dodd-FrankWall Street reform legislation passed in the wake of the2007-2009 financial crisis, when the U.S. government spentbillions of dollars on bailouts to keep big banks from failingand wrecking the U.S. economy.
The plans are separate from the Fed's stress tests, wherebanks demonstrate stability by showing how they would withstandeconomic and financial shocks in hypothetical scenarios.
"The FDIC and Federal Reserve are committed to carrying outthe statutory mandate that systemically important financialinstitutions demonstrate a clear path to an orderly failureunder bankruptcy at no cost to taxpayers," FDIC Chairman MartinGruenberg said in a statement. "Today's action is a significantstep toward achieving that goal."
But the agency's vice chairman, Thomas Hoenig, who was avoting member of the Federal Open Market Committee during thecrisis, said the plans show that no firm is "capable of beingresolved in an orderly fashion through bankruptcy."
"The goal to end 'too big to fail' and protect the Americantaxpayer by ending bailouts remains just that: only a goal," hesaid.
The three remaining large, systemically important banks,which the U.S. government considers "too big to fail," did notfare much better in their evaluations, but sidestepped potentialsanctions because they were not given joint determinations.
The FDIC alone determined the plan submitted by GoldmanSachs was not credible, while the Federal Reserve Boardon its own found Morgan Stanley's plan not credible. Citigroup's living will did pass, but the regulators noted it had"shortcomings."
The regulators' report coincided with the start of banksearnings reporting period and bank shares rallied. Wells Fargoshares rose 2.3 percent, JP Morgan was up 4.3 percent, Citigrouprallied 5 percent, Bank of America and Bank of New York Mellongained more than 3 percent each, and State Street was up 2.8percent.
Goldman Sachs said in a statement it has made "significantprogress" and Morgan Stanley said resolution planning is one ofits "highest priorities."
Citigroup was will work to address the shortcomings, ChiefExecutive Michael Corbat said in a statement.
The deficiencies across the five banks largely revolvedaround liquidity, governance and operations.
While JPMorgan has "made notable progress in arange of areas," the regulators said it "has keyvulnerabilities," including an inability to estimate theliquidity needed and available for funding bankruptcy resolutionand insufficient resources for winding down derivatives if itscredit ratings are cut.
On a conference call on JPMorgan's earnings, bank executivesexpressed disappointment with the determination and ChiefExecutive Officer Jamie Dimon said the bank has "tons ofliquidity."
"It's more about reporting, legal entities and things likethat," he said. "And if other firms can satisfy that I'd besurprised if we can't."
The agencies said Wells Fargo's living will"exhibited a lack of governance and certain operationalcapabilities."
By October it must demonstrate a "robust process to ensurequality control and accuracy" in its plan and lay out legallyhow different lines of business can be restructured and itsregional units can be separated.
Wells, State Street and Bank of New York all said instatements they will work to address the deficiencies by theOctober 1 deadline. Bank of America did not comment.
(Reporting by Lisa Lambert; Additional reporting by OliviaOran, Dan Freed and Lauren LaCapra in New York; Editing by ChizuNomiyama and Nick Zieminski)