The papers lead with the stock market going manic yesterday on bolstered confidence in Wall Street banks and another big rate cut by the Federal Reserve. The Dow Jones Industrial Average shot up more than 420 points (3.5 percent), the biggest point gain in more than five years and more evidence of the serious volatility that continues to roil markets.

Oddly enough, it was the second Tuesday in a row with massive gains. On the 11th, the Dow soared 417 points on a previous Fed cash drop. Forgot about that already, huh? The Wall Street Journal on C1 says last Tuesday’s gain was actually larger in percentage terms than yesterday’s and asks in its sub-headline if it’s a “One-Day Wonder.”

Banks and investment banks led the rally, with Lehman Brothers skyrocketing 46 percent and more than recouping its losses in the last week. Bloomberg says it was the biggest day for financial stocks since 2000.

When bad news is good

What sparked the buying? Earnings reports at Lehman and Goldman Sachs showed profits fell 57 percent and 53 percent respectively. That’s normally a very bad thing but not in this market, which feared much worse. The WSJ calls the rally a “measure of how bad things have gotten lately” and says investors exhaled because they found no signs of Bear Stearns-style cash problems in either firm’s quarterly report. Each company had about $2 billion in asset write-downs in the quarter, but that raises questions about whether they’re valuing the assets correctly according to so-called mark-to-market rules.

The San Francisco Chronicle quotes a banking analyst saying that Lehman’s conference call “was perhaps the best conference call in a couple of decades.” Having sat through a few earnings calls ourselves we can attest that’s not saying much, but Lehman appears to have laid out carefully its financial situation in as transparent a manner as possible.

Quote of the Day goes to Bloomberg:

“Getting some reinforcement that the wheels weren’t falling off of all the brokers was a great thing, because everyone was fixated on the troubles at Bear,” said E. William Stone, who oversees $77 billion as chief investment strategist at PNC Wealth Management in Philadelphia. “It had gotten so negative that people were thinking the entire financial system might be collapsing, so anything short of that was seen as a positive.”

Fed battle plan

That’s remarkable if true, since the Fed dropped its benchmark federal-funds rate by 0.75 percentage points to 2.25 percent and said more cuts are on the way. It was only the second time since 1994 the Fed has delivered such a big decrease, the WSJ says on page one.

The Los Angeles Times claims that the Fed move is intended to get investors out of CDs and money-market accounts and back into stocks. That’s a pretty shaky thesis, though the paper notes correctly (and obviously) that the move is intended to entice lenders to lend. Duh.

The Journal lists the massive government forces arraying for battle against the financial crisis:

The Fed’s actions are among several aggressive steps throughout the federal government that are coming to a head this week and could prove critical in combating the crisis. Today the regulator of Fannie Mae and Freddie Mac, which provide the bulk of funding for home mortgages, is to announce an easing of their capital requirements and the companies are to pledge to raise more capital, people familiar with the matter said. Those steps should enable them to back more mortgages.

Meanwhile, the Bush Administration which has so far resisted using large amounts of public money to save borrowers and lenders from bad loans, may be ready to compromise with Democrats on a more activist approach to the housing crisis. The Fed is “running out of pages in its playbook to address the growing crisis of credit and confidence,” Senate Banking Committee Chairman Chris Dodd, who has proposed the Federal Housing Administration insure up to $400 billion in troubled mortgages, said yesterday. Now the Bush administration should be “equally aggressive.”

At the same time, all the papers note that the Fed indicated that inflation will now weigh more heavily on its future decisions.

Will JP Morgan get its Bear?

The Bear just won’t go down without a fight. Investors pumped up Bear Stearns stock to nearly $6 a share yesterday—triple what JP Morgan has agreed to pay. That’s what they call one helluva spread on the arbitrage desks on Wall Street, which bet on or against the likelihood of a merger going through.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.