Bashed banks basking in spotlight lead Russell to 2nd best day of ‘09

Small-cap stocks stormed higher Wednesday as investors anticipated the government taking quick steps to remove toxic assets from bank balance sheets and perhaps forming a “bad bank” facility to further mop up mettlesome losing bank paper, which would in turn loosen lending habits. The Russell 2000 (NYSE:IWM) rose 17.44, or 3.83%, to 473.02, generating the second-largest one-day gain of the New Year. For 2009, the Russell is off 5.3%, while the Dow is down 4.5% and the S&P 500 is down 3.2%.

As for cleaning bank books of losing paper, it’s a familiar story, one that was supposed to be the focal point of the whole Troubled Asset Relief Program (TARP) in the first place, but which got sidetracked when Bush Administration officials decided they would get more bang for the buck via direct capital infusion into banks. The stock market has repeatedly rallied on signs that the TARP funds would be used to buy up those troubled assets, and momentum under the Obama Administration seems headed that direction, hence investors were happy to gobble up bargains on beaten down bank and financial shares.

The market also got a brief extension of the rise in the afternoon after FOMC members said they were prepared to buy longer-term Treasury products to help lower rates further out on the curve now that Fed funds rates are essentially at zero. The immediate beneficiary of that announcement was the Treasury market, but the U.S. dollar, the Mexican peso and even crude oil futures rallied — at least for a moment — on the news. After a very brief upside pop on the announcement, Treasury prices then started to cascade lower, however, as debt traders in essence called the Fed’s bluff, taking a stance that saying they will buy longer-dated paper just isn’t the same as actually doing it. Yields on benchmark 10-year notes went from about flat right after the FOMC statement to rising more than 5% by the stock market close.

Banks were clearly the star of the stock market show today, with the KBW . . .

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