The Dow Jones industrial average rose 130 points in light trading volume. Goldman has long been considered the strongest bank amid the economic downturn, but Bank of America has been one of the hardest hit by loan losses. Any improvement in banks’ profits could shore up their financial position and free money for lending.

Investors latched on to Whitney’s comments because she has for years offered one of the more pessimistic — and accurate — assessments of the banking business. While she still remains cautious about the industry over all, the shift in tone gave investors a jolt. Bank of America (NYSE: BAC), JPMorgan Chase & Co. (NYSE: JPM), and Citigroup Inc. (NYSE: C) are all scheduled to report second-quarter results this week. Banks have taken some of the biggest blows among U.S. companies since the recession began in late 2007 as investment and loan losses mounted. ”There is a contingency of traders out there that believe the market can’t recover without financials,” said Randy Frederick, director of trading and derivatives at Charles Schwab. Earnings reports will give investors a chance to see whether there was any meaningful economic improvement during the second quarter, and so far expectations are low.

Stocks rallied in the spring amid hope of a recovery in late 2009, but the market has struggled since mid-June as more investors began to doubt that assessment. In early afternoon trading, the Dow rose 130.97, or 1.6 percent, to 8,277.49. The Standard & Poor’s 500 index rose 15.20, or 1.7 percent, to 894.33, while the Nasdaq composite index rose 23.01, or 1.3 percent, to 1,779.04. Among financial stocks, Goldman (NYSE: GS) rose $7.51, or 5.3 percent, to $149.38 and Bank of America rose 83 cents, or 7 percent, to $12.71. The KBW Bank Index, which tracks 24 of the nation’s largest banks, rose 4.6 percent. Not all financial stocks rose. Commercial finance lender CIT Group Inc. said it is talking with regulators about ways to improve its short-term liquidity as recent losses may jeopardize its compliance with capital requirements.

Treasury Secretary Timothy Geithner said Monday, from London, that he was confident the government has the authority and the ability to address the crisis at CIT. The stock tumbled 31 cents, or 20.6 percent, to $1.22. Earnings reports are expected from major companies in a range of industries this week, including Dow industrials components Johnson & Johnson, International Business Machines Corp. and General Electric Co. and technology bellwethers Intel Corp. and Google Inc. ”People are focused on sectors battered the most to see if there is any bounce-back,” said Dan Deighan, founder of Deighan Financial Advisors in Melbourne, Fla.

Financial firms and retail companies will probably be the most closely watched industry as earnings are released, he said. Data coming out this week also will offer insight into the economy. Investors will get readings on inflation, retail sales, industrial production and housing starts throughout the week. Last week, stocks continued a four-week slide as the Dow dropped to 8,147, its lowest level since April 28. Since mid-June, investors have been giving back some of the 40-percent gains picked up during a vigorous rally that began in March. Concerns have been mounting that the rally was overdone and investors are now waiting for fresh signs the economy is actually improving instead of just weakening at a slower pace. The gains in stocks cooled demand for the safety of government debt, hurting prices and lifting yields. The yield on the benchmark 10-year Treasury note rose to 3.31 percent from 3.30 percent late Friday.

All told, the government is currently facing $8 billion in losses on the 10 biggest investments it made – and that’s after accounting for the $424.1 million paper gain on Morgan Stanley (MS Quote) shares and the $271.6 million paper profit on Goldman Sachs (GS Quote) shares. 

For those keeping score, the Treasury owns almost $200 billion in preferred stock from 532 firms, but 8 firms account for $134 billion. In all, the bailout is now more than $3 trillion, which is just about as much as the entire federal budget for last year. Morgan Stanley and Goldman Sachs are the only 2 out of the 10 biggest government investments that are in the money. Aside from those two bright spots, the only other good news for taxpayers is that the government collected $2.5 billion in dividends from its banking investments through March 31. 

So my recommendation to Treasury Secretary Tim Geithner is to take the money and run if any banks are ready to buy back the preferred shares and repay the bailout money they took. If taxpayers have to wait for the shares of these banks to top the strike price, we may be stuck with these investments for a very long time.

Several major banks that underwent the government stress tests of their ability to withstand a severe economic downturn have asked to repay TARP as soon as possible. The government has not yet announced who and when, and does not expect to until around the second week of June. Recommendations will likely come in batches rather than one bank at a time, the official said. 

But regulators worry that banks trying to get out of TARP are overestimating their prospects and could be forced to return for more money if the economy falls off a cliff. Experts believe the government will allow TARP recipients to repay funds only over time, perhaps 12 months, rather than all at once. Goldman Sachs Group Inc, JPMorgan Chase & Co, and Morgan Stanley have applied to repay TARP funds. 

Earlier this month, regulators told nine of the 19 big stress-tested banks that they did not need more capital. The government created TARP last fall to unlock the flow of credit after credit markets were brought to a near halt by shocks such as Lehman Brothers Holdings bankruptcy. At first, banks viewed TARP money as a positive, signaling government confidence. But TARP also allows the government to unilaterally impose restrictions, including on pay back, and many investors now believe holding bailout money signals weakness. 

Many banks have met major requirements to repay funds, including sales of debt not backed by the government. However, regulators have not made clear what other factors they are considering, such as how much can be repaid at once and on what terms, or what they will charge banks to buy back warrants giving the government a right to buy stock over time. Policymakers are causing confusion among large banks about what the Treasury Department must see before deeming a bank safe outside TARP, said a financial industry source familiar with the talks about repayment.  The Treasury Department is also concerned that if it lets some banks repay TARP but not others, investors will punish those banks deemed to be falling behind. 

Several analysts said many members of Congress are tired of throwing taxpayer money at the banking system. Lawmakers are eager for repayments but do not want the funds to go back into TARP, where the money could be available for future rescues.

The stress tests were designed to see how the large banks and finance companies would fare if the economy worsens.  Although Citigroup will be asked to raise more money, the amount is much less than what experts believed they would need.  Shares of Citi should continue to climb higher as they are now being singled out as one of the winners of the government’s stress test.  Bank of America and Wells Fargo also will have to raise money, aaccording to the results of the tests.

The stress tests are a centerpiece of the new Obama administration’s plan to stabilize the financial industry. They measure how much the banks would be hurt if unemployment rose to 10.3 percent and home prices dropped an additional 22 percent The government wants the firms to have enough money to keep lending even if the economy gets much worse. Officials have said none of the banks will be allowed to fold.

Regulators have stress tested the 19 largest U.S. banks to determine their capital needs should economic conditions deteriorate further. Officials have said that they will release the results in some form this week. The markets are anxiously awaiting the results as investors try to figure out which banks are on the path to recovery and which might face pressure to raise more capital, possibly through government funds.

Investors have embarked on their own guesswork, crafting their own results of the governments’ tests. Some banks’ shares have already been punished following early leaked reports that they will need more capital. Citigroup may have to raise more capital, according to preliminary results of its stress test, people familiar with the matter said on Tuesday, and Bank of America Corp may need billions of dollars more, the Wall Street Journal has reported.

Most experts agree that the idea of the stress tests has changed since Treasury announced the exercise in February. The original intention was to use the tests to determine which banks might need to participate in a new government capital infusion program, but market appetite for information on banks’ health has expanded its significance. Officials have said that the public disclosures will likely allow outside analysts to test their own assumptions of the banks’ health against regulators’ assessments.

However, a document the Federal Reserve released last Friday revealing the underlying assumptions of the stress tests did not include many specifics. The government has to decide whether to release the results of individual banks next week, or just disclose summary information for all the tested banks. Regarding whether banks themselves self disclose, bank examination findings are generally exempt from U.S. Securities and Exchange Commission disclosure requirements. Some experts have argued that the stress test process has risen to the level of a material event that investors should be informed about.

The Fed met with 19 of the top financial institutions to go over the stress test results. In some cases, some of the tests with each party took less than 30 minutes.  In addition, several of the banks, when tested, mentioned a need for more capital, but no one yet knows who those banks are.  In fact, not all of the identities of the 19 financial institutions that were subjected to federal stress tests have yet been learned. Analysts believe that they likely include regional banks with large exposures to commercial real estate in the Midwest and Southeast. Those few that are familiar with the matter said at least three banks are in this position.

Government officials believe most banks, in need, can improve their capital footing without taking money from the government bailout fund. This could be done by raising funds from private investors or converting the government’s existing investments in banks into a new type of equity that would better cover banks in case of future losses. In another scenario the U.S. could end up owning large chunks of banks, raising the specter of something akin to nationalization. Federal officials have said any such move would be temporary.

Some banks could end up requiring a cash infusion from the U.S. Treasury. For those banks  it will become very difficult to obtain private funding.  The word from the Fed from all of their meetings was to zip up about the results of the test. However, as this is Washington, we should  know just about everything by Monday or Tuesday.