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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.

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.

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.