The auction gave the market a quick but short-lived boost and raised the question of whether the Fed again whiffed in an attempt to sooth investor fears.
"The Fed moves, obviously, in the short term are all about perception. We saw that last week," said Randy Carver of Carver Financial Services. "I think economically it's not going to make a huge difference, but from a perception standpoint if we don't see additional liquidity, the market will jerk down again."
Morgan Stanley earnings were the other big story of the day, with the second-largest investment bank showing huge losses from subprime mortgages though the firm will benefit from a $5 billion cash infusion from China.
Morgan Stanley reported it had $9.4 billion in subprime writedown exposure, far worse than the expected $6 billion. However, Morgan also said it had the cash infusion of $5 billion will come after it sold a stake to China Investment, causing shares to move well higher, though trading was mixed across the sector.
"We are way, way oversold on financials, because people are scared. They don't trust it," said Richard Berg, CEO of Performance Trust Capital Partners. "We're looking for professional investors who we respect to come and say valuations are just too low."
Meanwhile,home builder Hovnanian said after the bell Tuesday it lost $7.42 a share, including accounting and land impairment charges, while revenue sank 20 percent and signed contracts dropped 10 percent. The stock, which has been beaten down this year, saw shares tumble.
Energy, Tech Lead Gainers
Shares were up at Exxon Mobil, Chevron and ConocoPhillips and across the energy spectrum as oil surgedabove $91.50 a barrel.
International Business Machines led Dow components to the plus side as investors looked for bargains in tech stocks, while 3M and McDonald's were the biggest laggards among the blue-chips.
Also in the tech sector, shares of Palm fell sharply after the company on Tuesday reported a quarterly loss and forecast revenue for the current quarter below expectations. The company was hit by a delay in delivery in its Treo 755 smartphone.
Darden Restaurants, owner of the Olive Garden and Red Lobster casual dining establishments, saw its shares tumble after it lowered guidance for 2008.