Dow Beats Doomsayers

Bies also noted in her speech that loose liquidity is part of why the banking sector is faring well amid the subprime market's decline. But liquidity is also what makes traders nervous about the subprime mortgage market's potential to have a spillover effect into the broader markets.

"What puzzles me is when you hear about big international banks like HSBC(HBC Quote) and JPMorgan Chase(JPM Quote) and Citigroup(C Quote) involved in this corner of the mortgage market," says Bear Stearns' Driscoll. "The biggest and bluest of them all are involved in the same desperate search for an extra 80 basis points. You wonder how much more is out there."

Meanwhile, liquidity helped fuel another round of merger activity. Sirius Satellite Radio(SIRI Quote) and XM Satellite Radio Holdings(XMSR Quote) announced plans to merge. Shares jumped 6% and 10.2%, respectively, on the news, despite possibly insurmountable regulatory hurdles.

Elsewhere, Vulcan Materials (VMC Quote) agreed to acquire Florida Rock Industries (FRK Quote) for $4.6 billion. Vulcan Materials dipped 0.6% while Florida Rock soared 42% on the news.

Driscoll says that the day's M&A news is not responsible for the market's rally Tuesday. The markets are used to M&A Mondays (or Tuesday, in this case, because of the Presidents Day holiday) at this point, he says.

"What this broader M&A Monday trend says to me is that there is a long-term comfort zone in corporate America," says Driscoll. "These guys are comfortable owning and buying stocks."

Indeed, 2006 made the record books for M&A activity in the U.S. and globally. Thus far, 2007 is shaping up to be equally strong. Year to date, M&A activity is up 27% from the same period in 2006, according to Dealogic. Globally, year-to-date M&A activity is up 29%.

So, more M&A, a spate of strong earnings and a benign take on the subprime mortgage market from the Fed's banking expert kept the bulls back on top after the long weekend. Interest rates and Fed policy will quickly be back on the scene Wednesday, which brings the January FOMC minutes and core consumer price index.