The Treasury secretary, Henry Paulson, appeared on CNBC’s “Squawk Box” yesterday morning, and some who viewed the program didn’t know whether to laugh or cry.

Mr. Paulson engaged in an awkward game of cat and mouse with the interviewers, who, naturally, thought Mr. Paulson might shed some light on what the government might do about the rising tide of victims of the subprime debacle. He didn’t, instead insisting that things aren’t so bad.

Henry Miller, the chairman of Miller Buckfire, a boutique investment bank specializing in financial restructurings, would disagree. Mr. Miller is voting with his feet: He is moving his firm to larger quarters. Bankruptcy filings have proceeded at a slow pace for the past few years, but that is expected to change.

Mr. Miller says that, though the firm was busy last year working on the reorganizations of Dana Corp., Interstate Bakeries, and Calpine, to name a few, there were few new assignments.

“That changed in the second half of December,” Mr. Miller says. “All of a sudden the phones lit up.”

Good news for Miller Buckfire, but not for most investors. Why the sudden change? Mr. Miller explains: “Over the past three years, the buildup of liquidity in the economy was extraordinary, and it prevented defaults from happening.” Mr. Miller says it wasn’t a case of corporations performing better than they have historically, but rather the availability of capital, mainly from “the lunatic fringe of hedge funds,” who pushed others out of the market. Mr. Miller sums up the formerly sanguine state of the debt markets thus: “Merrill Lynch has a high yield index tracking over 1,000 corporate issuers, with distress being defined as securities trading at least 1,000 basis points over Treasuries. At one point last year, only four companies qualified as distressed.”

Mr. Miller says that, historically, defaults on high-yield bonds and leveraged loans have run at about 3% to 4% annually. In December, according to a report released Tuesday by Moody’s, the American default rate dropped to less than 1%, its lowest level in more than two decades. On a global basis, too, defaults approached their lowest level since 1981, ending the year at 0.9%. Moody’s expects that number to rise to 4.8% by the end of this year, and to return to its historical average of 5% in 2009 — and it’s not even expecting a recession.

According to Ken Meehan of Debtwire, several issuers have missed interest payments in recent weeks; as the 30-day traditional grace period for such events expires, those issuers could well end up in default. Companies on the list include Buffets Inc., a restaurant chain; MAAX, a producer of bath products; Tekni-Plex, a maker of packaging products that is suffering from higher oil prices, and homebuilder Tousa Inc. Moody’s also said that its speculative-grade corporate distress index, which measures the portion of companies whose debt is trading at distressed levels, amounted to 11.5% at year-end, the highest level since mid-2003. A year ago the index was 4.2%.

Is this a blip? Mr. Miller says he certainly doesn’t think so. “We’ve been of the opinion for some time that we are in a consumer-led recession,” he says. “The precipitating factor was the subprime crisis and the follow-on credit crunch.” Mr. Miller says he thinks the damage done by the mortgage catastrophe will spill over to a number of industries, some of which are already feeling the pain, such as homebuilders, retailers, and manufacturers dealing in home-related products.

He says he thinks that financial institutions face more bad news as credit card problems grow, and that recent accounting guidelines have exacerbated the problems. “Ironically, the banks have known for some time that credit card defaults could rise. But because they can’t over-reserve now, there was no way they could build up reserves and soften the impact.”

Mr. Miller also says he thinks some of hedge funds could report pretty surprising write-downs. “We’ve been waiting for year-end; many funds are likely to have some pretty ugly marks-to-market,” he says.

How can investors profit from this gloomy outlook? The president of A.H. Haynes & Co., Amanda Haynes-Dale, says she thinks this is the perfect time to invest in distressed funds. Ms. Haynes-Dale manages a fund-of-funds called Pan-Ross, which rewarded investors with gains of better than 20% last year. (Wilbur Ross was a “passive co-general partner” in her original offering). A contributing factor in her 2007 gains was an investment with one of John Paulson’s funds. Mr. Paulson is the fellow who racked up enormous gains last year by shorting the ABX index.

Ms. Haynes-Dale is in the process of setting up a distressed fund-of-funds, to be called Pan Special Opportunities Fund. Distressed funds have not been particularly great performers of late, but Ms. Haynes-Dale is among those who think the sector is due for a bounce. According to HedgeFund.Net, funds specializing in distressed securities were up 6.4% last year, their worst performance since 2000. By comparison, hedge funds overall were ahead 10.8%. The distressed sector got socked badly by the credit market turmoil in August and November. An analyst for HedgeFund.Net, Peter Laurelli, writes that the distressed group typically follows a poor year with a barnburner. He cites gains in 1999 of nearly 20% and in 2001 of 16% as having come after years similar to 2007.

Overall, Ms. Haynes-Dale says, during the 16-year period between 1990 and 2006, distressed funds returned more than 15% a year; only in 1998 were such funds down, losing 4.5% on average. Further, she says distressed funds outperformed the S&P 500 75% of the time during those years. Her enthusiasm for the sector stems from the rising likelihood of a recession, following the most rapid credit constriction, according to the Federal Reserve, that the country has ever seen.

Rising default rates should provide distressed managers with improved opportunities, Ms. Haynes-Dale says, and she has selected six who should participate. The six come at the sector in different ways, affording investors some diversification. For instance, some managers invest in trade claims or vendor protection notes, while others specialize in post-bankruptcy debt or high-yield instruments.

The funds selected include Andromeda Global Credit, a product of Constellation Capital Management, and various funds managed by Longacre Capital Partners, Wexford Spectrum, Scottwood Partners, M.D. Sass, and Schultze Partners. Ms. Haynes-Dale is already an investor in another fund run by the first four firms; only the last two are brand new associations.

Investors have a choice: They can hope for a quick turnaround and try to pick off some overly depressed stocks, or they can invest in a fund that will profit from hard times. Mr. Paulson’s performance tended to steer us toward the latter choice.

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