Recovery of U.S. Economy Contingent on Stabilizing Financial System

Following a dramatic Wall Street rally on Tuesday which saw the Dow Jones industrial average gain 379 points, with the Standard & Poor’s 500 climbing 43.07 points and the Nasdaq composite going up by 43.07 points, the market inched slightly higher again on Wednesday, leaving stock market investors wondering whether this should be seen as a sign for optimism. Tuesday’s market surge has been primarily attributed to Citigroup’s report that the troubled financial institution traded profitably in both January and February. In light of the fact that Citigroup had reported five consecutive quarterly losses, made use of government assistance, and saw its stock fall below a dollar during last week, this was welcome news indeed.

While Citigroup was the bearer of good news, it wasn’t the only player in the financial sector to notch up gains on Wednesday, and was joined by Bank of America, Wells Fargo, JP Morgan Chase and Goldman Sachs. There has been mixed reaction to the market rally among the experts with the general consensus being that, until there is some concrete evidence that U.S. banks are back on track, with troubled assets under control and consumer credit flowing, any gain on Wall Street is likely to be temporary.

This viewpoint echoed that of Federal Reserve chairman Ben Bernanke who noted on Tuesday that the recovery of the U.S. economy was contingent on stabilizing the financial system. With this goal in mind, he has proposed new policies which among other things, is aimed at absorbing possible future financial shocks. Financial institutions that are deemed to be too big to fail will come under the spotlight. Bernanke emphasized that these large interconnected financial firms pose what he terms as a “systemic risk” to economic stability. He noted that allowing financial institutions to grow to the extent that government rescue is preferable to allowing them to fail, reduces market discipline and allows for, or even encourages, unwarranted risk taking. Federal bankruptcy laws are to be reviewed, steps will be taken to strengthen the nation’s financial infrastructure, and support for the credit and mutual fund markets will be investigated. Bernanke has further recommended that Congress put in place a “systemic risk authority” which could oversee the standards for liquidity, capital and risk-management practices in the financial sector. It is anticipated that hard lessons learned from the current global financial crisis will result in measures being put into place to avoid this happening again in the future.