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According to a recent article in The Wall Street Journal, banks and other financial institutions are acquiring foreclosed homes at a faster rate that they can sell them. Fannie Mae in particular purchased 44,071 homes during the first half of 2008, but has only sold 23,627. As of June 30, their balance of unsold homes was 54,173.

This bleak picture isn’t likely to change in the immediate future. Barclays Capital puts the tally of bank-owned American homes at 721,000, compared to just 112,000 two years ago! Furthermore, they expect an increase of 60% before the end of 2009.

As you can imagine, Fannie Mae and other financial institutions saddled with these foreclosed real-estate properties are very motivated, possibly even desperate, to sell them. Specifically, bulk purchases at very low prices, such as those we’ve chronicled elsewhere on this blog, are now being accepted, when in more robust economic times it’s unlikely they would even be considered.

As the saying goes, one man’s trash is another man’s treasure. The foreclosed accounts that U.S. banks are so eager to sell, even at less than 50% of the price such accounts were worth a few years ago, spell opportunity for saavy and motivated investment firms that specialize in management of distressed assets.

While this is bad news for many Americans, certain investors can eventually turn a profit by acquiring these foreclosed accounts in bottom-dollar bulk purchases, holding onto them until America’s real-estate crisis abates, and then selling them at top-dollar prices.

According to the New York Post, foreign investors have begun purchasing billions of dollars worth of foreclosed American real estate.  It’s not hard to see why. REO (real-estate owned) homes have fallen so drastically in value that they are worth anywhere from 31-80 cents on the dollar.

A foreign sovereign (state-owned) fund from Adu Dhabi is one such investor, and has begun investing in distressed U.S. real-estate assets.  With a reported $875 billion in assets, this fund has the resources to invest in and make a considerable profit from North America’s foreclosed homes.

Mark Hanson, a consultant for Field Check Group Mortgage, has been hired by an unnamed foreign sovereign fund to search for particularly good foreclosed home accounts.  He is narrowing his search to REO homes.  So far, he has secured an outstanding deal:  a $2 billion package of foreclosed American homes, at 31 cents on the dollar.

While these types of deals might still be unusual, they will become increasingly common as America’s financial market undergoes more bank failures and real-estate woes.

Enoch Lawrence, senior VP of CB Ricard Ellis, sums it up: “This type of bulk buy would make an impact on the market.  They (foreign sovereign funds) are in a unique position because they have a long time horizon to invest and a cheap cost of capital.  It’s actually a perfect time for them to acquire these REO assets.”

It’s not just foreign sovereign funds that stand to profit in this market.  If you read more of this blog, you will see notable examples of shrewd U.S. investors scoring audacious deals.  If you want to maximize your profits during this economic downturn, you’d be wise to consider working with like-minded investors.

In case there was any doubt, 2007 mortgages are in serious trouble. The Federal Deposit Insurance Corporation’s analysis, which ran in The Wall Street Journal, indicates that .91% of 2007 prime mortgages were “seriously delinquent” (i.e., in foreclosure or 90 days late) after a year, compared to just .33% in 2006. That’s almost a three-fold increase!

Freddie Mac reports much the same, with 1.38% of 2007 loans being delinquent, compared to .38% of 2006 loans.

According to Mark Zandi, chief economist for Moody’s Economy.com, “foreclosures will remain at record highs, the financial system will be under severe stress and the broader economy will sputter.” He goes on to say that more recent loans, those from 4th quarter 2007 and early 2008, seem to performing more successfully.

What this means for resourceful investors is that there are a disproportionate number of distressed 2007 mortgages littering the financial landscape right now. As we’ve already mentioned in this blog, the trading of distressed debt is increasingly popular on Wall Street, and an increasing number of investment companies are making a profit from this practice.

For those who are in a position to invest in these companies, now is the time to do so.

Call it hubris, or just plain denial, but according to Zillow’s Q2 Homeowner Confidence Survey, most U.S. homeowners consistently overestimate the value of their own homes, despite empirical evidence to the contrary.

Specifically, the survey found that 62% of U.S. homeowners think the value of their home has either increased or remained steady; but, in actuality, 77% of U.S. homeowners have suffered from declines in home values.

It’s tempting to dismiss this as other folks just needing a reality check, but the truth is that it’s human nature to dismiss numbers and statistics as affecting other people, and to discount the danger of abstract threats until they more or less smack us in the face.

What this means for the housing market is anyone’s guess.  Personally, I think it still has further to go in its downward spiral.  Not a cheery thought, but the Zillow survey indicates that many American homeowners seem to think it’s business as usual, for them at least.

When ugly reality hits some of these people, as it inevitably will, there are going to be some mortgages in trouble.  There are smart companies out there poised to make a profit by buying up these mortgages for a song.  Reselling them for a higher price once the current crisis passes will net these companies serious profits.

As an investor whose funds may be performing sluggishly, you should consider investing in companies that can maximize the potential profits from these distressed accounts.

A recent Reuters report states that an increasing number of hedge funds are investing part of their portfolios in distressed assets.  A survey of 100 hedge fund managers by the Schwartz Cooper law firm found that more than 60 funds have invested in distressed companies, and almost 40 funds plan to buy assets from such companies within the year.

Richard Bendix, director of the survey, explains it this way: “Hedge funds are under increasing pressure from their investors to perform, but the risks associated with that performance have increased dramatically.”

For investors and fund groups planning to invest in distressed assets, it is paramount that they fully understand insolvency situations, namely, their legal obligations should they be unable to sell their stakes in distressed companies.

These responsibilities aren’t dissuading an increasing number of investment firms.  The fund managers surveyed are especially interested in the housing, automotive, construction, and energy sectors as upcoming distressed asset opportunities.

Whatever their inherent risks, it’s becoming clear that distressed assets are a growth opportunity too lucrative for aggressive investors to pass up.

With the economy in the toilet, savvy and boldness can land investors incredible deals. As we’ve mentioned, one potentially lucrative buy, which takes full advantage of the general skittishness now plaguing banks and investment firms, is the purchase of distressed assets for bottom-dollar prices.

Case in point: investor John P. Grayken’s Dallas-based private equity firm, which earlier this week inked a fantastic deal with investment titan Merrill Lynch. Lone Star paid a paltry $6.2 billion for Merrill Lynch’s distressed-asset mortgage investment accounts. Grayken must be grinning. His firm paid 22 cents on the dollar, netting a package with a face value of $31 billion. Furthermore, Merrill Lynch also agreed to finance 75% of the price, therefore taking responsibility for the majority of any potential losses from accounts that don’t succeed.

Stated in more mundane terms, this is roughly the equivalent of paying $6,200 for a $31,000 car, and then having the seller promise to pay for 75% of all potential future repair costs.

Smarts and aggressiveness serve distressed-asset management companies like Lone Star Funds and Team Nation Holdings well.  Still, as the truism states, timing is everything. By knowing when to exploit the anxieties of the marketplace, these companies can secure deals that would be unheard of during calmer, healthier economic times. Furthermore, many of these distressed accounts can be immensely profitable once the economy regains its footing and the marketplace follows suit.

Lone Star and Team Nation aren’t the only ones engaging in this practice. According to The New York Times, “the business of trading distressed debt is undergoing a renaissance on Wall Street, as money managers and traders search for ways to profit from fears that defaults will keep rising on a wide range of consumer and duplicate loans.”

One caveat: if this practice were easy, more investors would do it. If you decide to allocate part of your investments into this increasingly popular niche area, find a company that specializes in this practice. With their help, your returns could be substantial.

At a time when many people are concerned about what the downturn in the market has done to their investments, smart investors start looking for places to grow their money that doesn’t follow the general downward trend.

Well, they say that crisis breeds opportunity, and so it does. Many of the smartest investors are turning for ways to leverage the changing market by focusing on distressed assets.

The International Finance Corporation (part of the World Bank Group) is one such institution that supports purchasing distressed assets.

“IFC offers a comprehensive package of services in distressed asset investing, including long-term loan financing, equity and mezzanine financing, technical assistance, and advisory services. Our involvement provides comfort to international investors, local partners, and governments, and is often a catalyst for other investors.”

Basically the idea is that large companies will often sell their distressed assets at a rate much below going market price, offering an area that can show substantial gains for people with the experience and know-how to turn such situations around.

With the market facing a downturn in many areas, investing in distressed assets has never looked more promising.