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In yet another turnaround for holders of mortgage-backed securities, the Federal Reserve announced it will buy $600 billion in such assets.

Attempting to deal with the financial crisis, the Fed says it will purchase up to $100 billion in direct obligations from Fannie, Freddie, and the Federal Home Loan Banks.  Another $500 billion in mortgage-backed securities will round out the picture.

Firing all the ammunition would seem to be the general strategy, as the Fed combines this new initiative with additional incentives to unfreeze the consumer debt market — including $200 billion to security holders backed by various types of consumer loans.

Will this effort stave off the deepening recession?  Only time will tell.  In any case, it seems that investors in distressed assets can once again look to a powerful financial institution for backing.  This can only mean greater opportunity for those knowledgeable enough to take advantage of this latest move.

As noted in past entries — when companies face financial difficulty, distressed asset opportunities are often ripe for the taking. Just ask Wilbur L. Ross Jr., the man who helped restructure the bankrupt steel industry and earned a tremendous return. Is now the time to let industries like the Big Three automakers slide into bankruptcy? In this article from The New York Times, Ross does not go that far. The two industries — steel and automaking — are like apples and oranges. Ross favors some form of government intervention, to reduce catastrophic ripples that might destroy suppliers and dealers connected with the auto industry.

“Bankruptcy [for the auto industry] will be a total mess, and may not produce anything of value at the end of it,” Mr. Ross said.

Still, in listening to a man like Ross, who made bets on Indian airlines in July — foreseeing the end of the oil bubble — one gains insight into a perspective shared by many specialists in distressed assets, namely that one company’s misfortune is another investor’s opportunity.

With a government rescue plan for the Big Three, if the government cannot ‘crack enough heads’ in order to straighten out the failing automakers, they would have no choice: “The government would have to have the fortitude to say, ‘We’re not going to keep pumping in money,’ and mean it,” says Mr. Ross.

If market value was an illusion when stocks were soaring, who’s to say it’s no illusion when stocks are flooring?! So say investment specialists Marty Whitman and Curtis Jenson of the Third Avenue Value fund. Arguing for optimism in this article from The Wall Street Journal, Mr. Jenson offers “…unprecedented opportunities in the distressed debt market.”

Calling many current valuations “ridiculous,” the managers at Third Value have pressed ahead with high-yield bonds.

Third Avenue Value has been buying select bonds from GMAC, as well as bonds from a trucking company — Swift Transportation — and expects either a yield at maturity of 19% or a valuable slice of equity if Swift is forced to restructure.

Indeed, in a recent letter to his shareholders, Mr. Whitman predicts some yields as high as 54%.

How do you take advantage of opportunities in high-yield bonds during these difficult times? If Jensen and Whitman are correct, the key is optimism, and a group of investment specialists who know how to value distressed assets.

Like yin and yang, risk and opportunity go hand in hand, and if this article from Reuters is right, investors hoping to capitalize on refinance-driven opportunities in Asia will have plenty of possibilities in 2009.

“The biggest elephant in the drawing room is the refinance trade,” said Robert Appleby, chief investment officer at Hong Kong-based ADM Capital.

Companies like ADM are anticipating billions in distressed asset opportunities in the coming year, and with nearly $500 billion in debt expected to mature on the Asian market, many more opportunities should arise as companies seek to get creative in their restructuring efforts.

Right now investors are looking to ride out the coming global recession, but such economic troubles are actually fostering an environment ripe for specialists in distressed assets. Appleby maintains that the Asian market is ‘the best in a lifetime’ for investing in distressed debt, perhaps better even than during the Asian financial crisis of 1997-1998.

Though warning that investors should still be patient for the right opportunity, Appleby notes that the current selling frenzy is putting a lot of ‘good debt’ out on the market, and turning such debt into profits should be easy for the savvy investor.

With such a rapidly-changing financial scene, it might be a good idea to take a step back and gain some perspective. The New York Times has established a timeline detailing the events that defined this financial crisis. Though the picture seems dire, smart investors know that great difficulties also present great opportunities. Where is the light at the end of this seeming chain of dominoes? Read on…

Sept. 7, 2009 — Henry M. Paulson, Jr., justifying the conservatorship of Fannie Mae and Freddie Mac, tells the public that these two government-sponsored entities are “…so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in the financial markets here at home and around the globe…”

Lehmen Brothers, AIG, and even Merrill Lynch — “the thundering herd of brokers around the nation” — fell victim to the crisis. Wall Street resembled a trauma victim as onlookers wondered how to ’staunch the bleeding…’

Ultimately, the government had no choice but to rescue AIG, which was — in words that would become increasingly common in the media sphere — ‘too big to fail…’

Finally, the system seemed to be near the breaking point — even Morgan Stanley and Goldman Sachs could no longer escape regulation, and Washington Mutual became the largest bank failure in the history of the United States. Congress had no choice but to step in with a financial bailout plan. At the time, those seeking returns from distressed assets thought that they might have the government’s backing. Indeed, prior to the bailout, Paulson assured the public that the Treasury was working to “…address the root cause of our financial system’s stresses…illiquid mortgage assets that have lost value as the housing correction has proceeded…”

Ultimately, despite the best efforts of Federal regulators and foreign banks which seemed at first glance better-regulated than U.S. systems, the financial crisis spread beyond the U.S. to the shores of Europe and Asia.

Where is the light at the end of the tunnel? As we noted in our most recent post, there is room for optimism, despite the recent announcement that distressed assets will no longer be the focus of TARP.

And one thing remains certain — investors looking for tremendous payoffs can look to distressed assets that will become increasingly affordable as they are priced to sell. Despite our troubled times, any objective observer would agree that troubled assets will eventually show some return for the investors savvy enough to scoop them up at these bargain prices. For those interested in such potential, a sure-fire bet is to find a team of professionals to guide them in selecting those assets that are guaranteed to win big.

Echoing a recent blog-entry from October 13, Warren Buffett praises the ‘American system’ and advises investors to embrace the government’s program for the economy in this clip from Youtube. Buffet’s penultimate advice: “Be greedy when others are fearful…”

Today, in a stunning reversal, Treasury Secretary Henry Paulson said that the government isn’t going to buy all those distressed assets after all! That is bad news for the taxpayers, who will not get the same return on Paulson’s other “investments”. But it’s good news for people who are willing to buy at a time that distressed assets will be going for rock-bottom prices. Don’t take my word for it though, ask the richest man in the world…

How does Buffett feel about investing in distressed assets? It’s a sure bet. Buying distressed assets at distressed prices is a proven method to make money, according to Buffett. The government wouldn’t be spending taxpayer money, says Buffett, but investing it.

Where others see difficulties, Buffett sees opportunity.

“Confidence will come back,” he says. Buffett offers that the American economy has created a seven to one increase in the U.S. standard of living over the last century, despite the difficulties of two world wars, a flu pandemic, and even the Great Depression. Likening the American economy to an athlete who is ‘down but not out,’ Buffett says, “We’ve got all the ingredients for a sensational future.”

Now that the government isn’t buying, you can bet the prices for distressed assets will be lower than ever. If you can find a team with the expertise to filter out the good loans from the bad, you will make a pile of money.

Earlier this summer, TheStreet.com Financial Advisor Richard Widows offered some good advice for those interested in distressed asset investment. He addresses two basic points: when to invest and what to invest in.

Widows admits the obvious, which is that there’s no universally known “best time” to invest in distressed securities. He does state that markets have a tendency to anticipate early recovery (although admittedly, this was published in June, before the $#@! hit the fan in the U.S. economy).

As to the question of what to invest in, Widows has a bit more to say. In a word, diversification. Diversifying one’s holdings is a wise plan, and one way of achieving this is to purchase shares in mutual funds that invest in distressed assets. Many such funds offer “dollar cost averaging,” which spreads out investments over time. This helps address the question of when to buy, since the fund will best decide that.

Widows suggests four different that specialize in distressed asset investments. The Franklin Mutual Recovery Fund invests in distressed companies, risk arbitrage, and securities special situations/undervalued securities. The Masters Select Focused Opportunity Fund specializes in distressed companies, including high yield bonds, bank debt, and other indebted company purchases. The Highland Credit Strategies Fund invests domestically and internationally in a variety of different areas: fixed rate loans, bonds, debt obligations, and mortgage and asset-backed securities. Finally, the Pioneer High Income Trust invests 80% of its assets in high yield debt, distressed, and convertible securities, loans, and preferred stocks.

It’s likely that there are other funds out there focused on distressed asset investments, as well as companies that can offer helpful distressed asset investment advice. If you want to learn more, do yourself a favor and read some of the other Smart-Stock blogs on the subject.

South African billionaire Johann Rupert plans to work with sovereign wealth funds to acquire distressed assets, due to their collapsing prices. Rupert’s family owns the retail jewelry company Cie. Financiere Richemont SA.

He told Bloomberg.com reporter Thomas Mulier, “I’m seeing very interesting opportunities right now, distressed sellers, but I don’t think they’ll disappear.”  The Richemont company plans to create the satellite investement company Reinet, specifically for distressed asset investment.  The intent is for Reinet to cooperate with several other major and sovereign wealth funds in such investments.

Investors like Rupert and Buffet are certainly savvy enough to recognize opportunity when it’s there.  The rest of us might not have their wealth, but that doesn’t mean we can’t take advantage of similiar opportunities, either independently or with help.

The global trend of falling property market prices has brought with it increased investor interest in distressed assets. Last month, Business 24/7 writer Darren Stubing described this investment trend amongst hedge funds and private equity funds.

Many financial strategists look to 2010 and beyond as a likely date for future recovery in the asset prices for distressed mortgage accounts, underscoring our consistent message that distressed asset investment should be part of a patient investor’s investment portfolio.

Stubing points out that distressed assets can include CDO (collateralized debt obligations) assets, and that these may not technically be distressed due to poor credit. This makes CDOs an attractive investment option.

According to Stubing, “distressed asset funds raised $30 billion (Dh110bn) in the second quarter of 2008, up significantly from the previous quarter.” Additionally, several blue-chip investment firms are creating their own distressed asset funds or investing heavily in such funds. Blackstone Group, Carlyle Group, and Private Equity Partners are among those who have raised between $1 to $2 billion.

Such investment focus is not just a U.S. trend. Across Europe, India, and Asia, many funds and firms are following suit. London hedge fund GLG Partners has created a team of distressed asset experts to help them invest heavily in the market. Another British firm, The Berkeley Group, is looking to buy up distressed development land. Worldwide, the list goes on.

Finally, the three-year trend for global asset investment is as follows: $13 billion in 2006, $33 billion in 2007, and an expected $60 billion plus in 2008. Impressive.

In an article in last month’s Barron’s, Jonathan R. Laing makes a compelling case in favor of the U.S. government’s $700 billion bailout plan.  Given the feelings of disgust and indignation on the part of some taxpayers towards this plan, it’s worth summarizing a few of Laing’s key points.

Most significantly, many of those distressed accounts (primarily mortgages and mortgage securities) that Uncle Sam is buying from banks, insurance companies, and credit unions aren’t as toxic as many people think.  Furthermore, these Treasury Department purchases will accomplish several things: freeing up credit markets, increasing home-loan backed security prices, and eventually slowing the trend of plummeting real-estate prices.

Mortgage fund TCW’s CIO Jeffrey Gundlach had this to say: “Essentially this secondary effect would do much to lift housing out of its funk and actually improve the performance of the securities that Treasury ends up buying…Thus, I think that there’s a good chance that the bailout plan will be a win-win for both the taxpayer and the financial system.”

Bill Gross, manager of Pimco bond fund, maintains a similarly sanguine outlook.  His estimation is that the distressed assets the Treasury will buy will be worth approximately 65 cents on the dollar.  When financed at 3% to 4% from the sale of Treasury debt, the Treasury can potentially earn a positive amount of 7% to 8% on its purchases.

Laing helpfully points out the irrationality inherent in Chicken Little thinking: “By most accounts, current losses on U.S. mortgage paper — the difference between face value and current fire-sale prices — stand at about a trillion dollars. In a sign of the distortions from panic selling, eventual losses on the underlying mortgages figure should be no greater than $250 billion. The market, irrationally, is assuming losses of four times that amount.”

Laing provides more insightful information, which we might address in future blogs.  Suffice to say, the sky is not falling.