Dow up 400 on greater likelihood of bailout vs. no bailout

NEW YORK (CNNMoney.com) -- Stocks rallied Tuesday afternoon as investors scooped up shares battered in the bloodletting that followed Congress' failure to pass a $700 billion bank rescue plan.

But credit markets remained frozen. Several closely-watched measures of bank lending fear hit all-time highs, as firms continued to hoard funds.

The Dow Jones industrial average (INDU) added 400 points before scaling back a bit, with 90 minutes left in the session, recovering some of the record 777 points lost the day before.

The Standard & Poor's 500 (SPX) index rose 4.6% and the Nasdaq composite (COMP) gained about 4.3%.

The advance was largely in response to the previous session's selloff, in particular the swell of sell orders that poured in near the close of the session, said Alan Lancz, director of Lancz Global.

"There was panic selling yesterday, so today you're seeing a reflex rally or a dead cat bounce," Lancz said.

He said the stock advance could also imply investors expect that some form of the government plan will pass, perhaps by the end of the week.

Bank rescue plan: Stocks plunged Monday after the House of Representatives shot down the proposed $700 billion bank rescue plan, surprising investors who had thought that a bipartisan compromise on the deal had been reached over the weekend.

The plan involves the Treasury Department buying up bad mortgage bets from banks, enabling them to start lending to each other again and ultimately defrosting the credit markets. Lawmakers had fought to modify the plan with more taxpayer protections.

However, taxpayers were not entirely swayed, and voter complaints about the plan ahead of the election contributed to House Republicans largely voting against the proposal. (Full story)

Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and other officials conceived the plan in the wake of a series of bank failures and mergers amid the housing market collapse and subsequent credit market freeze up. Frozen credit markets mean banks cling to cash, making it difficult for businesses and individuals to get needed loans.