In today’s semi-political investment environment, it starts to become a little hazy whether we’ve turned the corner or whether we’re still headed for an even worse market crash. Press reports have praised the work of Treasury Secretary Henry Paulson and Congress for diverting the economy from a new version of the Great Depression.

The only problem is that their plan has not been adopted. It still must run the gauntlet of the U.S. Congress. Anyone who knows something about politics understands that trying to get a bill passed is like playing a grown up version of telephone – you may not get out what you put in.

Here is what we know so far. While the plan has been dubbed the “son of RTC” – referencing the independent Resolution Trust Corporation that bought the assets of failed savings and loans in the 1980s – it will be very different from the RTC.

While the RTC took the assets of defunct savings and loans, wiping out shareholders, the Paulson process is looking to protect Wall Street. The U.S. Treasury Department will buy as much as $700 billion in toxic assets from institutions that are still solvent. Shareholders in the bailout firms will have their equity cut, but not destroyed.

Unfortunately, this will protect the same corporate dynasties that ran many of these firms into the ground with excess leverage. It also moves these depreciating assets onto the balance sheet of the U.S. government.

But there is something important that investors need to take away from this current meltdown…

The bailout, while important and publicized, is distracting many from the bigger long-term picture. And that’s opened the doors for us to score some great bargains.

The Risks of a Bailout Plan… and the Benefits for You

By holding “reverse auctions,” the Treasury plans to buy these loan portfolios from multiple banks. But the greatest danger is government officers buying assets that no one understands. How much they are really worth? Banks could offload non-performing assets with larger risks than currently disclosed.

When risks are divorced from investments, you naturally have an increased opportunity for fraud.

In my opinion, the wholesale nationalization of much of the mortgage market and many banks sets a bad precedent. And the plan’s insuring of money-market funds guarantees managers taking more risks will climb and the due diligence of the buyers will fly out the window. Before long, all of Wall Street will be selling bad assets here.

America has over 200 years of bankruptcy law that should be governing these transactions. If managers who accumulated too much risk by not adequately qualifying lenders are allowed to continue in their jobs, we are doing a disfavor to the intelligent managers who accepted lower returns for more prudent lending practices.

I believe the shareholders and executives at these mismanaged firms should be wiped out. These investments have clearly failed, and management is to blame. It’s the risk we all take, and the risk of investing. It allows new managers and companies to fill the void. This type of creative destruction – however painful – always strengthens the economy in the long run.

The silver lining is that many of these investments may come back to benefit the consumers. In the final review of the Savings & Loan bailout, U.S taxpayers saw a net gain from their “purchases.” And the simple reason behind it was that assets were purchased for less than they were worth and sold at a profit when their value was realized.

It’s the very principle behind deep-value investing.

Why the Imbalance in Stock Prices?

The current mess has created lots of imbalance in stock prices. As thousands of financial “professionals” worry about their job prospects, stock prices are getting hammered. But that doesn’t mean that all of these companies deserve this mistreatment. There are solid businesses out there that have been completely undervalued by the market.

I’ve long been a proponent of contrarian investing and buying assets on the cheap. It delivers superior long-term returns and uncovers portfolio “superstars.” And it seems that I’m not the only one beating the pavement for deep values…

Warren Buffett just took a $5 billion stake in Goldman Sachs (NYSE: GS), with the ability to buy another $5 billion more. And MidAmerican Energy, one of his subsidiaries, just bought Constellation Energy (NYSE: CEG) shares for half of what they were trading at earlier this month.

Clearly Buffett has been using the liquidity crisis to grab some phenomenal bargains. And we should be on the lookout for the same. The market’s recent fluctuations have been offering investors some tantalizing buys. (Take a look at today’s crib sheet for 3 ideas.)

So keep a level head and invest with caution in the current environment. The rules of the game are changing and short-term relief could be replaced with higher inflation and a longer bear market.

But that doesn’t mean there are some great values out there.

Good investing,

Floyd G. Brown
Investment U