What you're missing, moJoe, is that we have free will. God does have infinite empathy--but we have an infinite, God-given right to reject that empathy. The best exposition of this idea is in The Great Divorce by C S Lewis. It's a series of dialogues between a bunch of damned people and their saved friends. All the damned people have to do to be saved is walk to heaven--but they won't. The saved people try desperately to convince their friends to leave Hell behind, but most of the damned people decide that Hell is more attractive for various reasons.

The whole point of human spirituality is to come to a closer relationship with God. Since each person's relationship with God is somewhat different, each person is going to have to do somewhat different things to further it. That's why "being a nice guy" doesn't necessarily cut it. If being a nice guy doesn't bring you closer to God, it won't get you closer to heaven. On the other hand, being an asshole (or whatever) doesn't definitively cut you off from God either. To paraphrase the Pope, there must be a Hell, but nobody has to be in it. If humans have ultimate freedom, then we must have the right to choose our own destiny, to be with God or not. But whether anyone chooses to abandon God is all about them, not about God. Furthermore, the decision to abandon, or not abandon, God is such a personal one that it's generally better to refrain from guessing about the state of other people's souls.

Update: Baptism by desire was traditionally applied to people who died during the preparatory period before baptism, not to people who were part of different religions. The Catholic Church still says that there is "no salvation outside the Church," but it doesn't clearly say what you have to do to be in the Church. I spent 6 months researching the topic for my MA thesis in Catholic theology. Vatican II presents three different descriptions of "membership in the Church" without either endorsing or rejecting any of them. It also makes a rather confusing distinction between the Church and the people of God that meant different things to different people, even at the time it was written. It's safe to say that the Catholic Church doesn't have an official teaching on this subject at the moment.

The Catholic/Lutheran agreement is only tangentially related, since the question of justification by faith or works is separate from the question of how those works and/or faith are recognized.