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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.

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.

could well be the title of a recent article by AP Business Writer Rachel Beck, published online at FindLaw.com.  Beck explores the attitudes of Wall Street investors towards distressed asset sales to Uncle Sam.

Troubled U.S. financial institutions stand a better chance of profitably selling their toxic accounts to the government than they do selling them to investors in the financial market.  Additionally, Hedge and sovereign wealth funds will likely find a way of selling these accounts to the government.

The U.S. government may well be their only buyer, at least in the near future.  Many private investors are either making bottom-dollar offers or are unable to obtain loans that would enable them to buy.

Bill Goss, CIO and founder of Pacific Investment Management Co., predicts that the U.S. government will pay around 65 cents on the dollar for mortgage securities.  Considering how low some private investor offers have been (between 20-30 cents on the dollar), it would probably be wise for today’s troubled financial firms to take the deal.

Beck also makes the observation that the firms that qualify for the government bailout can boldly buy risky accounts on the cheap, and then sell them to Uncle Sam for a quick profit.

Or, as former hedge fund manager Andy Kessler says, “Any time there is a big pile of dough, guys on trading desks will figure out how to make money off of it.”

Truer words were never spoken.

A common theme throughout this blog is that the ongoing U.S. financial crisis brings with it investment opportunities.  This message is one that resonates globally.  GIC, a sovereign fund located in Singapore, hopes to uncover such opportunities, and is currently searching for distressed asset investments within the U.S.

The International Herald Tribune published an article last month that describes how GIC (Government of Singapore Investment Corp.) has already invested $18 billion of its $300 billion total assets in UBS Investment Bank and Citigroup, and intends to invest more in distressed assets.

Ng Kok Song, GIC’s CIO, affirms that “Problems in the U.S. would present very interesting opportunities in impaired assets…We are seeing a lot of opportunities both in public markets as well as private markets such as real estate.”

AMP Capital’s Shane Oliver, who heads AMP’s investment strategy, elaborated: “With shares already cheap and the risk of a meltdown and global depression likely to recede there is now a good chance that we have seen, or at least come very close to, the low for the bear market.”

Since no one is certain how much further the U.S. economy can fall, most experts caution investors to be both selective and patient in their investment strategies.

GIC’s move towards distressed assets anticipated by several days a similar move by investment bank Goldman Sachs, which allocated $10 billion (half of which originates from Warren Buffet’s Berkshire Hathaway company)   towards distressed asset investment.

From time to time, it’s worth pointing out that distressed asset investment is a global practice, as illustrated by an article last Thursday in reuters.com.

Ashmore Group, a British fund firm, considers the British economy rife with “significant” investment opportunities in the distressed assets field.

The British economy is also taking a beating, with Assets Under Management (basically, the market value of assets managed by an investment company for its investors) falling 14.7 percent during the first quarter of 2008.

Nevertheless, an Ashmore Group spokesperson foresees “significant investment opportunities…for its funds, notably in the special situations and corporate high yield asset classes, as de-leveraging creates distressed seller opportunities where the underlying businesses are strong.”

What’s true for American investors and investment firms is likely true for their British counterparts: during diffcult economic times, distressed assets can be purchased for very low prices.

In an interview with cnbc.com, Buffet basically echoes what several high-profile investors are already saying. Namely, that the U.S. Treasury should partner with private investors in the purchase of distressed assets. Buffet predicts that such a move would create real market prices for such assets. Furthermore, he contends that the government can very likely make a profit if it buys these assets at market prices. Ever the man to put his money where his mouth is, Buffet promises to take 1% of the government’s deal.

In his own words: “I think it’s important to have market-based prices. One way to get there would be to have the Treasury, we’ll say, finance various institutions that would put 20 percent of their own money in to buy these mortgage securities that are for sale. The Treasury would lend 80 percent. Whoever put up the 20 percent would not get a dime back until the Treasury got all of its money, plus interest, plus perhaps a share of the profits. You would get real market prices that way. You’d get people that knew the game.”

It’s pretty clear that increased accessibility on the part of investors to the many distressed/toxic accounts (be they mortgage or otherwise) will lead to increased economic activity, as well as to higher returns.

An article last week on boston.com about distressed asset investment echoes the sentiments described in last week’s blog; namely, that some of the country’s most significant investors are clamoring to buy up the same distressed assets as Uncle Sam.

Bank of New York Mellon and Boston’s Bain Capital, and investment firms like New York’s Blackstone Group, are among those hoping to make such buys.  Ronald P.O’Hanley, BNY Mellon’s CEO, wants his group’s trillion-dollar investment group to have the same access to distressed assets as the government:

“We’re suggesting that it’s a way to implement the bailout, to have an auction. We’re suggesting that it go beyond the Treasury, and that the Treasury right from the beginning invite others in to invest with them. There are lots of distressed funds waiting to buy. An auction process will provide a mechanism to bring those players in.”

Think about it.  These immensely wealthy companies wouldn’t be so gung-ho to invest in distressed assets if there weren’t serious opportunities for profit.  Furthermore, unlike the nation’s banks, private equity firms like these are in relatively solid financial shape, allowing them to buy up such assets.  Better private equity firms paying for them than us, the taxpayers.

According to a recent dallasnews.com article, ”New Vultures” is the recent term some folks are applying to those who invest in distressed assets.  I’d be inclined to consider this sour grapes on the part of those unable or unwilling to seek out long-term profit opportunities in the midst of a financial crisis.

It’s fitting that, in Texas, a state famed for it’s larger than life gestures, there have been several investors (who prefer the more flattering moniker of “opportunity funds”) moving in to grab failing assets like mortgage-backed securities and real estate accounts for a pittance, with the intention of holding onto them until their prices increase again.

This certainly isn’t an easy process, but it’s worth it.  In the words of Craig Hall, a Dallas-based real estate developer who has joined another broker to purchase distressed realty accounts:  “It’s a lot of risk-taking and a lot of work…We’re going to see one of the greatest transfers of wealth in our lifetime.”

The transfer he refers to is that of vulnerable property owners, banks, and other financial institutions eager to sell their distressed accounts for pennies on the dollar.

Many analysts feel that the U.S. housing prices can fall even further, which will continue to drive down the price of distressed real estate assets.  Furthermore, there’s no way the U.S. government can purchase all these accounts and other debts, which creates substantial opportunities for New Vultures/opportunity funds.  And it won’t just be the housing markets that have distressed accounts for sale.

Investors such as Hall and Texan developer Fehmi Karahan perceive credits cards, car loans, office buildings, undeveloped land, and other areas as potential sources of distressed asset purchases.  Says Karahan, who created a fund to purchase distressed real estate, “Everything that’s being talked about is related to subprime and mortgages, but there are a lot of commercial projects that in my mind are the ’subprime’ of that industry. You may see another wave of things that shouldn’t have been built and are leveraged too thin hit the marketplace in the next two to three years.”

What this all adds up to is investment opportunity.  And while you don’t have to live in Texas or wear a ten gallon to take advantage of it, you do have to “man up” and put your money to work.

One of the trends in this time of economic crisis is the cashing out on the part of hedge fund investors.  The New York Times published an article yesterday about this very subject.  Considering the house’s rejection of the proposed bailout package, such a cashing out (and loss of investor confidence) seems likely.

Basically, during this period of insecurity and uncertainty, hedge funds are bracing for a series of investor withdrawals, which will force some hedge funds to dump investments (including distressed assets).

According to James McKee, director of hedge fund research at San Francisco consulting firm Callan Associates, “Everybody’s watching for redemptions, and there could be a cascading effort, where redemptions cause other redemptions.”

Some hedge funds are losing money, and some of closing down entirely.  Over 350 have been liquidated so far this year, up about 24 percent from last year.

So where’s the good news in all of this?

For those hedge funds and investors who have the assets, bravery, and patience to weather this storm, they will benefit from seeing many of their competitors vanish.  Furthermore, not all in the industry have lost faith in hedge funds.

David E. Smith, CEO of Coast Asset Management, a Santa Monica, Calif. based fund worth $5.6 billion, believes that “It’s clearly been a very tough year for investors in general, but I think hedge funds have done a good job of navigating very tough markets and don’t get the type of recognition that they should.”