THE enduring rally in real estate investment trusts finally ended this year as turbulence in the credit markets rattled the confidence of commercial investors and effectively halted the frenetic pace of REIT privatizations.
Now the question on some people’s minds is whether the downturn means that a lingering bear market is looming.
For more than seven years — from November 1999 through January 2007 — REIT shares soared in value, providing investors with average annualized returns of 23.6 percent. In 2006 alone, REITs climbed by an average of 34.4 percent.
But the market is poised to finish 2007 sharply lower. This year through Thursday, the REIT composite index compiled by the trade association had a negative return of 11.39 percent. The index of equity REITs, which own commercial property and constitute the bulk of the market, has fallen 8.63 percent.
Meanwhile, losses for mortgage REITs, which originate loans and invest in mortgage-backed securities, were a staggering 43.5 percent, on average. By contrast, the Standard & Poor’s 500-stock index is up around 6.4 percent so far in 2007.
“It’s been a very ugly year,” said Mike Kirby, a principal of Green Street Advisors, a real estate research company in Newport Beach, Calif., echoing the sentiment of many others. “It’s one of the worst performances we’ve seen in REIT land in a long time.”
Industry analysts and money managers, though, had been predicting for a while that the REIT market would run out of steam.
Fortunes reversed, they say, just as a giant private equity firm, the Blackstone Group, was completing its $36 billion acquisition of Equity Office Properties Trust, the nation’s largest office landlord. “That was when the market peaked,” Mr. Kirby said.
Indeed, part of the reason for the REIT run-up was the record number of mergers and acquisitions, about half of which involved leveraged-buyout deals by private firms with voracious appetites for commercial property. As investors tried to predict which REIT companies, or sectors, might be singled out next, share prices surged.
Last year, there were 23 announced transactions totaling $106.15 billion, including the assumption of debt. But so far this year there have been only 18 transactions totaling $68.69 billion. Only one deal has been announced since July 25.
Analysts attribute the falloff to a reluctance among financial institutions to provide loans for buyouts in light of the credit squeeze that swept through the subprime mortgage market as the housing market softened.
Because REITs themselves typically have only moderate levels of debt, they have generally fared well in the credit crisis; the noted exception, of course, has been mortgage REITs.
Nonetheless, concern has grown that the credit problems may eventually weaken the economy and therefore hurt demand for commercial space.
Real estate fundamentals are still in pretty good shape by historic standards. Occupancy is in the low- to mid-90 percent range across the board by geographic and property types, and there’s positive rental rate growth.
But even though these business fundamentals are relatively strong, securities prices have dropped. REIT performance, Mr. Kirby noted, “had been pretty decent at the operating level and poor at the share level.”
Whether REIT shares stay depressed is open for debate. The last bear market, in which annualized losses averaged 13.18 percent, lingered for 23 months until November 1999. The one before that lasted 14 months, from August 1989 to October 1990, average annual returns during that market were a negative 20.86 percent.
“REITs have been in a bear market pretty much all year,” said Ralph L. Block, the author of “Investing in REITs” (Bloomberg Press, 2006) and the publisher of The Essential REIT, a newsletter. “I think the key to forecasting what REIT stocks do in 2008 is determining whether the U.S. is going into a recession.”
Our good friend Paul E. Adornato, a senior REIT analyst at BMO Capital Markets, agreed. “This is the key uncertainty going into 2008,” he said, adding that investors “will be focusing on the macroeconomic issues — rather than real estate fundamentals — such as job growth.”
But we also think that investors must overcome a perception problem. I call it a perceptual connection. Investors are hearing that real estate is softening, so they think that that must mean all real estate is bad. They don’t stop to think that the value of their homes in which they live and the office buildings in which they work are two very separate markets.
At the same time, REITs seem to be lumped in with all financial stocks right now, noting that shares of financial services companies have been beaten down because of losses in their mortgage-backed securities businesses.
Still, we maintain that REITs have a lower correlation with most other stocks and bonds — in other words, they tend not to move in tandem with them — and that this makes them good portfolio diversifiers. Although we have seen the group get hurt when the general market goes down.
Now may be a good time to buy, citing industrywide data that shows REITs over all trading at a significant discount to asset value. According to Mr. Kirby of Green Street Advisors, the current average discount to net asset value is around 20 percent. For a long period of time they were trading at a premium. Let us hope this is not a value trap...
We ususally focus on the larger, so-called blue-chip REITs with excellent management, strong balance sheets and good business models. They also pay out regular dividends.
We particularly favor the REITs in the industrial sector — one of the stronger performers, with an average return of 9.13 percent so far this year — which invest in warehouses and distribution centers. This sector includes companies like ProLogis Trust. Prologis is rapidly expanding into Europe, China and India. Their global exposure will insulate them to some degree to the economic softness domestically.
We are less enthusiastic about the office sector, which has posted losses of 14.52 percent, on average, so far this year, and the apartments sector, which has had negative returns of 18.69 percent. Multifamily housing will continue to face head winds based on the oversupply of single-family homes for sale. Landlords have less pricing power. Although there are some office REITs that should be more resiliant to the slow down despite their stock price dropping dramatically. Stocks such as Corporate Office Properties for example. With a high percentage of their portfolio leased to government security agencies, an economic slowdown should not hurt them.
There are other REITs that we like that have come down in price. Call us if you want to discuss them...
Tuesday, December 18, 2007
Friday, December 14, 2007
Why the Fed bailout might not work
The announced plan to make credit markets more liquid could end up having the opposite effect.
The Federal Reserve's latest move to make credit markets more liquid could deepen problems in the banking system and actually cause the markets to be even more illiquid.
Wednesday, the Fed, along with other central banks, announced a plan that is designed to enable banks to borrow money directly from the Fed at below-market rates. This will allow a wider range of banks to access Fed credit, and simultaneously allow them to submit a broader range of collateral to the Fed when taking out those loans.
Why do this now? The Fed explained in a release Wednesday: "This facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress." In layman's terms this means that rates on loans between banks - measured by something called the London Interbank Offered Rate, or Libor - are too high for the Fed's tastes, so it is now prepared to itself lend to banks at much lower rates.
Before this move, banks could borrow directly from the Fed through the so-called discount window, at 4.75 percent. The key Federal funds rate is lower, at 4.25%, but that is open to a narrower range of financial institutions and accepts a narrower range of collateral than the discount window. The new program - called the Term Auction Facility (TAF) - will auction funds to banks at rates very close to the lower Fed funds rate. The first TAF auction, for $20 billion, is scheduled to begin on Dec. 17.
What could go wrong with such an approach? Surely, it makes sense for banks to be lending to each other at lower rates, since that can spark more lending across the whole financial system. But Libor is a market rate, ultimately reflecting banks' views on each other's creditworthiness. Indeed, at 5.06% before news of the TAF was released by the Fed, Libor was considerably higher than the Fed funds rate, reflecting banks' caution about each other. But maybe the widened spread between Libor and the Fed funds rate is an inescapable product of the times. Given the credit problems U.S. banks are facing, they are naturally wary of each other. Maybe the Fed thinks banks are being overcautious, so the TAF is its way of bypassing what it sees as unwarranted skittishness.
But it makes more sense to believe the banks' view of each other than the Fed's. Banks do business with banks each day, so they're far more likely to have a good handle on each other's balance sheet problems. Moreover, as theoretically profit-making entities, private banks have to carefully assess the creditworthiness of the borrowers, which means they have far more incentive to do their homework than the Federal Reserve.
The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made.
One of the big lessons of the credit crunch is that overly cheap credit causes massive harm to the economy in the long run. The TAF suggests that the Fed still hasn't learned that.
The Federal Reserve's latest move to make credit markets more liquid could deepen problems in the banking system and actually cause the markets to be even more illiquid.
Wednesday, the Fed, along with other central banks, announced a plan that is designed to enable banks to borrow money directly from the Fed at below-market rates. This will allow a wider range of banks to access Fed credit, and simultaneously allow them to submit a broader range of collateral to the Fed when taking out those loans.
Why do this now? The Fed explained in a release Wednesday: "This facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress." In layman's terms this means that rates on loans between banks - measured by something called the London Interbank Offered Rate, or Libor - are too high for the Fed's tastes, so it is now prepared to itself lend to banks at much lower rates.
Before this move, banks could borrow directly from the Fed through the so-called discount window, at 4.75 percent. The key Federal funds rate is lower, at 4.25%, but that is open to a narrower range of financial institutions and accepts a narrower range of collateral than the discount window. The new program - called the Term Auction Facility (TAF) - will auction funds to banks at rates very close to the lower Fed funds rate. The first TAF auction, for $20 billion, is scheduled to begin on Dec. 17.
What could go wrong with such an approach? Surely, it makes sense for banks to be lending to each other at lower rates, since that can spark more lending across the whole financial system. But Libor is a market rate, ultimately reflecting banks' views on each other's creditworthiness. Indeed, at 5.06% before news of the TAF was released by the Fed, Libor was considerably higher than the Fed funds rate, reflecting banks' caution about each other. But maybe the widened spread between Libor and the Fed funds rate is an inescapable product of the times. Given the credit problems U.S. banks are facing, they are naturally wary of each other. Maybe the Fed thinks banks are being overcautious, so the TAF is its way of bypassing what it sees as unwarranted skittishness.
But it makes more sense to believe the banks' view of each other than the Fed's. Banks do business with banks each day, so they're far more likely to have a good handle on each other's balance sheet problems. Moreover, as theoretically profit-making entities, private banks have to carefully assess the creditworthiness of the borrowers, which means they have far more incentive to do their homework than the Federal Reserve.
The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made.
One of the big lessons of the credit crunch is that overly cheap credit causes massive harm to the economy in the long run. The TAF suggests that the Fed still hasn't learned that.
Thursday, December 6, 2007
Roadblock to a subprime solution
The biggest obstacle to a mortgage bailout plan could be the investors who wound up with the bad debt.
A sweeping solution to the subprime lending crisis could get snagged by a big sticking point at the end of the mortgage chain.
On Monday, Treasury Secretary Henry Paulson said in a speech that its Hope Now coalition of government, industry and community groups is developing a streamlined way to move able homeowners into sustainable mortgages.
A large part of that plan, it's been widely reported, is to broadly rework adjustable rate mortgages (ARMs) for all borrowers who qualify and freeze their interest rates before they jump to unaffordable levels.
But investors in mortgage-backed securities, who buy the loans wholesale from lenders, aren't exactly jumping on board.
"You have contracts in place guaranteeing investors a fixed rate of returns," said Jim Carr, Chief Operating Officer of the non-profit advocacy group, National Community Reinvestment Coalition. "They have no immediate incentive to give up those returns."
Modification options for mortgage servicers are limited by contracts and tax laws. Servicers decide who would or would not qualify for a loan rework, but they can't make widespread modifications without an okay from investors.
Contracts between lenders and investors typically state that servicers can modify up to five percent of loans within a group without clearing it in advance. But modifying a higher percentage requires approval. The reworks called for by Secretary Paulson would probably exceed that five percent threshold in many cases.
But relaxed guidelines in October from private watchdog the Financial Accounting Standards Board gave servicers greater leeway in reworking loans if the modifications were in the best interest of investors.
The move was supposed to give the green light to a large-scale reworking of potentially delinquent loans. But investor reluctance stills seems to be a hurdle in applying the fix to an entire group of borrowers.
The American Securitization Forum (ASF), which represents investors and is part of Paulson's coalition, supports easier ways to modify mortgages for troubled borrowers, but according to spokeswoman Katrina Cavelli, it does not back an across-the-board solution to the problem.
In congressional testimony Friday, ASF Deputy Executive Director Tom Deutsch said that certain modifications are preferable to foreclosures, but they "should be considered and made on a loan-by-loan basis."
"There's a lot of technical work that has to be done before this program can be put into place," said Carr. There's also a rights issue, he said. "It could be argued that all borrowers within a group be treated the same."
Then there's the threat of investor lawsuits. Contracts between mortgage servicers and investors typically have two competing clauses, according Joe Mason, professor of finance at Drexel University. One requires servicers to act in the best interest of investors, and the other sets specific limitations on what servicers can do, including what modifications to loans can be made.
"Modifications are proceeding," said Mason, "and servicers are using the 'best interest' clause. It's not clear if that opens them up to investor lawsuits. It will be up to the courts to decide which clause wins."
Ultimately a mortgage rate freeze would result in higher home prices, according to Peter Schiff, president of retail investment brokerage Euro Pacific Capital.
"The [investor] will say, 'Wait a minute. The government can come back in a few years and alter contracts based on economic emergencies,'" he said.
Investors will want a higher return from their securities, and charge more for that added risk. "Because of government intervention, people will pay too much for their houses."
A sweeping solution to the subprime lending crisis could get snagged by a big sticking point at the end of the mortgage chain.
On Monday, Treasury Secretary Henry Paulson said in a speech that its Hope Now coalition of government, industry and community groups is developing a streamlined way to move able homeowners into sustainable mortgages.
A large part of that plan, it's been widely reported, is to broadly rework adjustable rate mortgages (ARMs) for all borrowers who qualify and freeze their interest rates before they jump to unaffordable levels.
But investors in mortgage-backed securities, who buy the loans wholesale from lenders, aren't exactly jumping on board.
"You have contracts in place guaranteeing investors a fixed rate of returns," said Jim Carr, Chief Operating Officer of the non-profit advocacy group, National Community Reinvestment Coalition. "They have no immediate incentive to give up those returns."
Modification options for mortgage servicers are limited by contracts and tax laws. Servicers decide who would or would not qualify for a loan rework, but they can't make widespread modifications without an okay from investors.
Contracts between lenders and investors typically state that servicers can modify up to five percent of loans within a group without clearing it in advance. But modifying a higher percentage requires approval. The reworks called for by Secretary Paulson would probably exceed that five percent threshold in many cases.
But relaxed guidelines in October from private watchdog the Financial Accounting Standards Board gave servicers greater leeway in reworking loans if the modifications were in the best interest of investors.
The move was supposed to give the green light to a large-scale reworking of potentially delinquent loans. But investor reluctance stills seems to be a hurdle in applying the fix to an entire group of borrowers.
The American Securitization Forum (ASF), which represents investors and is part of Paulson's coalition, supports easier ways to modify mortgages for troubled borrowers, but according to spokeswoman Katrina Cavelli, it does not back an across-the-board solution to the problem.
In congressional testimony Friday, ASF Deputy Executive Director Tom Deutsch said that certain modifications are preferable to foreclosures, but they "should be considered and made on a loan-by-loan basis."
"There's a lot of technical work that has to be done before this program can be put into place," said Carr. There's also a rights issue, he said. "It could be argued that all borrowers within a group be treated the same."
Then there's the threat of investor lawsuits. Contracts between mortgage servicers and investors typically have two competing clauses, according Joe Mason, professor of finance at Drexel University. One requires servicers to act in the best interest of investors, and the other sets specific limitations on what servicers can do, including what modifications to loans can be made.
"Modifications are proceeding," said Mason, "and servicers are using the 'best interest' clause. It's not clear if that opens them up to investor lawsuits. It will be up to the courts to decide which clause wins."
Ultimately a mortgage rate freeze would result in higher home prices, according to Peter Schiff, president of retail investment brokerage Euro Pacific Capital.
"The [investor] will say, 'Wait a minute. The government can come back in a few years and alter contracts based on economic emergencies,'" he said.
Investors will want a higher return from their securities, and charge more for that added risk. "Because of government intervention, people will pay too much for their houses."
Are either of these good ideas?
Bush plan will freeze subprime rates
The agreement will freeze certain subprime mortgages for 5 years, a compromise with the mortgage industry and banking regulators.
Clinton calls for subprime rate freeze
The presidential candidate's proposal covers borrowers who are both current and behind on their mortgage payments
Senator Hillary Clinton spelled out the details of her subprime bailout plan Wednesday, calling for a 90-day moratorium on foreclosures and a five-year freeze on the interest rates of adjustable rate mortgages (ARMs).
In August, the democratic presidential hopeful asked legislators to ban prepayment penalties on mortgages, but her new plan goes much further, and bears similarities to other proposals, including one expected to be offered by the Bush administration soon.
Clinton had already outlined her proposal in a letter to Paulson on Monday - the letter was posted onto her Web site - but on Wednesday she formally unveiled the comprehensive plan.
The rate freeze proposal would halt interest on ARMs from resetting above their low, introductory rates. Those resets can turn barely affordable mortgages into hopelessly unaffordable ones for many home owners.
"The average reset will increase the monthly payment by 30 percent to 40 percent," she said. A freeze would afford hard-pressed borrowers relief until the ARMs could be converted into fixed rate loans.
Clinton's freeze plan, which she unveiled at the Nasdaq Stock Market in New York, applies only to owner-occupiers, not real estate investors. Otherwise, no class or time frame of subprime ARMs issued was mentioned.
Interest rates on resetting ARMs can jump from 7 percent or less to 10 percent or more, costing borrowers hundred of dollars a month more.
The Clinton freeze proposal will cover both borrowers who are current with their ARM payments and ones who have fallen behind.
The 90-day foreclosure moratorium is meant to give lenders and mortgage servicers time to sort through the large numbers of borrowers who may benefit from the freeze, so none will lose their homes simply because servicers do not have the systems and staff in place to reach all the affected borrowers.
In addition to these main provisions, the Clinton plan also would require that lenders provide ongoing status reports on how many mortgages they modify and the types of modifications made. Earlier this year, Moody's revealed that servicers had modified few of the resetting subprime ARMs.
Despite congressional scrutiny, media coverage and pressure from community advocates, "the industry has modified only 1 percent of at-risk mortgages so far this year," said Clinton. According to Clinton, we cannot take the lending industry at its word that it will follow through on agreements to convert loans expeditiously.
The senator promised that, if her provisions are not included in an agreement Paulson reaches with lenders, she will push for legislation that will enable loans to be reworked without first obtaining the permission of investors.
Servicers are reluctant to rework loans due to contractual obligations with the actual owners of the liens, the investors. Protecting servicers against investor lawsuits may encourage them to modify more mortgages for home owners in distress.
Clinton's proposal also calls for up to $5 billion in funds to help hard-hit communities and individual borrowers withstand the foreclosure crisis. Part of the money would go to financial counseling, which has proven successful in helping borrowers work through solutions with lenders.
The Bush administration has hammered out an agreement with industry to freeze interest rates for certain subprime mortgages for five years in an effort to combat a soaring tide of foreclosures, congressional aides said Wednesday.
These aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of as much as seven years and industry arguments that the freeze should only last one to two years.
Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.
The administration said that President Bush will speak on the agreement at the White House on Thursday and the Treasury Department announced that Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson would hold a joint news conference Thursday afternoon with officials of the mortgage industry.
Paulson, who has been leading the effort to craft a plan, said on Monday that the program would only be available for owner-occupied homes - as a way to make sure that the break is not granted to real estate speculators.
The plan emerged from talks between Paulson and other banking regulators and banks, mortgage investors and consumer groups trying to address an avalanche of foreclosures that are feared as an estimated 2 million subprime mortgages reset from lower introductory rates to higher rates.
The higher rates in many cases will boost monthly payments by as much as 30 percent, making it extremely difficult for many people to keep current with their loans.
The plan is aimed at homeowners who are making payments on time at lower introductory mortgage rates but cannot afford a higher adjusted rate.
Through October, there were about 1.8 million foreclosure filings nationwide, compared with about 1.3 million in all of 2006, according to Irvine, Calif-based RealtyTrac Inc. With home loan defaults still rising, the trend is expected to worsen next year.
The plan represents an about-face for Paulson, who until recently had insisted that the mortgage crisis could be handled on a case-by-case basis. However, he and other administration officials became convinced that the tide of foreclosures threatened by the mortgage resets represented such a severe threat that a more sweeping approach was needed along the lines of a plan put forward in October by Sheila Bair, head of the Federal Deposit Insurance Corp.
Under the typical subprime loan, those offered to borrowers with spotty credit histories, the rates for the first two years were at levels around 7 percent to 9 percent. But after two years, those rates were scheduled to reset to levels around 9 percent to 11 percent.
For a typical $1,200 monthly mortgage payment, the reset could add another $350 to the monthly payment, greatly raising the risks of loan defaults by homeowners struggling with the current payment.
The wave of mortgage foreclosures threatened to make the most severe slump in housing even worse by dumping more foreclosed properties onto an already glutted market, further depressing home prices and shaking consumer confidence.
The deepening housing slump has already roiled financial markets, starting in August, as investors grew increasingly concerned about billions of dollars of losses being suffered by banks, hedge funds and other investors.
The administration plan is designed to deal with the crisis by allowing subprime borrowers who are living in their homes and are current on their payments to avoid a costly reset for five years. The hope is that by that time the housing downturn will have stabilized, clearing out the glut of unsold homes and halting the steep slide in prices that is occurring in many parts of the country.
With sales and prices once again rising, the expectation is that homeowners will be able to renegotiate their current adjustable rate mortgages into a more affordable fixed-rate plan.
The housing crisis has become an issue in the presidential race with Democrats Hillary Rodham Clinton and John Edwards putting forward their own proposals this week that would go further than the administration.
WWYD? What would you do?
The agreement will freeze certain subprime mortgages for 5 years, a compromise with the mortgage industry and banking regulators.
Clinton calls for subprime rate freeze
The presidential candidate's proposal covers borrowers who are both current and behind on their mortgage payments
Senator Hillary Clinton spelled out the details of her subprime bailout plan Wednesday, calling for a 90-day moratorium on foreclosures and a five-year freeze on the interest rates of adjustable rate mortgages (ARMs).
In August, the democratic presidential hopeful asked legislators to ban prepayment penalties on mortgages, but her new plan goes much further, and bears similarities to other proposals, including one expected to be offered by the Bush administration soon.
Clinton had already outlined her proposal in a letter to Paulson on Monday - the letter was posted onto her Web site - but on Wednesday she formally unveiled the comprehensive plan.
The rate freeze proposal would halt interest on ARMs from resetting above their low, introductory rates. Those resets can turn barely affordable mortgages into hopelessly unaffordable ones for many home owners.
"The average reset will increase the monthly payment by 30 percent to 40 percent," she said. A freeze would afford hard-pressed borrowers relief until the ARMs could be converted into fixed rate loans.
Clinton's freeze plan, which she unveiled at the Nasdaq Stock Market in New York, applies only to owner-occupiers, not real estate investors. Otherwise, no class or time frame of subprime ARMs issued was mentioned.
Interest rates on resetting ARMs can jump from 7 percent or less to 10 percent or more, costing borrowers hundred of dollars a month more.
The Clinton freeze proposal will cover both borrowers who are current with their ARM payments and ones who have fallen behind.
The 90-day foreclosure moratorium is meant to give lenders and mortgage servicers time to sort through the large numbers of borrowers who may benefit from the freeze, so none will lose their homes simply because servicers do not have the systems and staff in place to reach all the affected borrowers.
In addition to these main provisions, the Clinton plan also would require that lenders provide ongoing status reports on how many mortgages they modify and the types of modifications made. Earlier this year, Moody's revealed that servicers had modified few of the resetting subprime ARMs.
Despite congressional scrutiny, media coverage and pressure from community advocates, "the industry has modified only 1 percent of at-risk mortgages so far this year," said Clinton. According to Clinton, we cannot take the lending industry at its word that it will follow through on agreements to convert loans expeditiously.
The senator promised that, if her provisions are not included in an agreement Paulson reaches with lenders, she will push for legislation that will enable loans to be reworked without first obtaining the permission of investors.
Servicers are reluctant to rework loans due to contractual obligations with the actual owners of the liens, the investors. Protecting servicers against investor lawsuits may encourage them to modify more mortgages for home owners in distress.
Clinton's proposal also calls for up to $5 billion in funds to help hard-hit communities and individual borrowers withstand the foreclosure crisis. Part of the money would go to financial counseling, which has proven successful in helping borrowers work through solutions with lenders.
The Bush administration has hammered out an agreement with industry to freeze interest rates for certain subprime mortgages for five years in an effort to combat a soaring tide of foreclosures, congressional aides said Wednesday.
These aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of as much as seven years and industry arguments that the freeze should only last one to two years.
Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.
The administration said that President Bush will speak on the agreement at the White House on Thursday and the Treasury Department announced that Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson would hold a joint news conference Thursday afternoon with officials of the mortgage industry.
Paulson, who has been leading the effort to craft a plan, said on Monday that the program would only be available for owner-occupied homes - as a way to make sure that the break is not granted to real estate speculators.
The plan emerged from talks between Paulson and other banking regulators and banks, mortgage investors and consumer groups trying to address an avalanche of foreclosures that are feared as an estimated 2 million subprime mortgages reset from lower introductory rates to higher rates.
The higher rates in many cases will boost monthly payments by as much as 30 percent, making it extremely difficult for many people to keep current with their loans.
The plan is aimed at homeowners who are making payments on time at lower introductory mortgage rates but cannot afford a higher adjusted rate.
Through October, there were about 1.8 million foreclosure filings nationwide, compared with about 1.3 million in all of 2006, according to Irvine, Calif-based RealtyTrac Inc. With home loan defaults still rising, the trend is expected to worsen next year.
The plan represents an about-face for Paulson, who until recently had insisted that the mortgage crisis could be handled on a case-by-case basis. However, he and other administration officials became convinced that the tide of foreclosures threatened by the mortgage resets represented such a severe threat that a more sweeping approach was needed along the lines of a plan put forward in October by Sheila Bair, head of the Federal Deposit Insurance Corp.
Under the typical subprime loan, those offered to borrowers with spotty credit histories, the rates for the first two years were at levels around 7 percent to 9 percent. But after two years, those rates were scheduled to reset to levels around 9 percent to 11 percent.
For a typical $1,200 monthly mortgage payment, the reset could add another $350 to the monthly payment, greatly raising the risks of loan defaults by homeowners struggling with the current payment.
The wave of mortgage foreclosures threatened to make the most severe slump in housing even worse by dumping more foreclosed properties onto an already glutted market, further depressing home prices and shaking consumer confidence.
The deepening housing slump has already roiled financial markets, starting in August, as investors grew increasingly concerned about billions of dollars of losses being suffered by banks, hedge funds and other investors.
The administration plan is designed to deal with the crisis by allowing subprime borrowers who are living in their homes and are current on their payments to avoid a costly reset for five years. The hope is that by that time the housing downturn will have stabilized, clearing out the glut of unsold homes and halting the steep slide in prices that is occurring in many parts of the country.
With sales and prices once again rising, the expectation is that homeowners will be able to renegotiate their current adjustable rate mortgages into a more affordable fixed-rate plan.
The housing crisis has become an issue in the presidential race with Democrats Hillary Rodham Clinton and John Edwards putting forward their own proposals this week that would go further than the administration.
WWYD? What would you do?
Sunday, December 2, 2007
A radical plan to lower drug costs
If patents were replaced by government cash grants, market forces would dramatically lower drug costs, many experts believe. But Big Pharma isn't having it.
What to do about the high cost of drugs? A cadre of academics and economists has a radical new answer: Take away the exclusive product patents the government grants a new drug and replace them with cash awards to the innovating company.
Not surprisingly, this is one prize Big Pharma says it doesn't want. Even so, the idea of "prizes not patents" is gaining support and sparking a heated debate over the price of medical innovation.
Here's how the so-called "prizes not patents" scheme would work, according to its supporters: The federal government would set up an $80 billion innovation fund, and rather than grant exclusive patents, officials would use the pot of cash to reward each company's new drug discovery with a one-time prize. Regulators would then take the new drug's formula and place it in the public domain, where any other drugmaker can copy it, make a duplicate medicine, and rush it to market. The hope is that the ensuing market competition would generate dramatically lower prices for new medications.
Such policy notions would have little traction if not for the overwhelming feeling that drugs are too costly. Drug treatments are becoming an increasingly larger part of the U.S. healthcare budget. And as baby-boomers begin to sign up for Medicare's new prescription drug benefit, taxpayers and politicians are fretting the costs. Americans spent $274 billion on prescription drugs in 2006, an increase of 82% over spending in 2000. Medicine prices have risen faster than the rate of inflation in each year of this decade.
According to a study by the AARP Policy Institute, the average senior citizen taking four brand name medications saw a cumulative increase of $1,461 to fill prescriptions between 2000 and 2006. Reform advocates fear that increasing costs can limit patients' access to life-saving drugs. Some of the most expensive drugs, in fact, are those for cancer treatment.
Moreover, some policymakers believe prizes would solve more than just high prices. They say the plan would create an incentive for companies to research and develop medicines diseases that are more prevalent in developing countries - ailments drugmakers currently considered to be less lucrative.
If the new patent scheme sounds downright Soviet, that's because it is. Actually, the old Soviet Union tried awarding prizes for innovation, but according to most Russian policy experts, the system failed to generate scientific creativity. Supporters of this new plan point out, however, that the Soviet's were too stingy, and didn't offer large enough prizes.
The prize plan is gaining new clout in recent months. Nobel laureate economist Joseph Stiglitz advocated the idea in a recent syndicated column. "[T]he patent system with all of its distortions has failed in so many ways," Stiglitz lamented. Last month, Vermont Senator Bernie Sanders introduced the idea in the form of the Medical Innovation Prize Act of 2007.
Earlier this month on the presidential campaign trail, John Edwards promised to make drug patent reform a part of his healthcare agenda. The former North Carolina senator told a gathering in New Hampshire that the plan would "create a different dynamic for drug companies and particularly for breakthrough drugs in big areas like Alzheimer's, cancer, etc." "We'd offer a cash prize for research and development of these drugs, but they don't the patent," Edwards explained. "So, we eliminate the monopoly."
Big drugmakers shudder at the idea of more government involvement in their business. "A prize system could interrupt the flow of funding needed to guarantee research success and could inject the government into decisions about research priorities," says Ken Johnson, senior vice president of PhRMA, the drug industry's main lobbying organization. Johnson insists out that the current patent system hardly grants the lucrative monopolies critics describe.
While it's true, for instance, that patents last 17.5 years, unlike other industries, drugmakers conduct an average of about 12.5 years of research on medicines before they can gain FDA approval. That leaves roughly five years of patent exclusivity for a drug company to recoup its industry average $800 million investment. "We believe that any weakening of the current patent system could be potentially devastating for patients," Johnson says.
The idea of government prizes for drug innovation is the brainchild of James Love, an economist who is director of Knowledge Ecology International, a Washington, D.C.-based think tank. Love has made a name for himself in the nation's capital as a consumer advocate, lobbying and working to pass legislation in areas including technology, intellectual property and health care. He is often criticized for being anti-business, but he believes his prescription for drug companies couldn't be more pro-industry.
"We're saying we want to give $80 billion a year to biotechs, Big Pharma," says Love. "Is that really anti-business? To me, it's a market-oriented alternative to an unproductive, ethically challenged system. Patients prefer a free market, but they don't like monopolies where you pay $100,000 a year for cancer medicines."
So where does the $80 billion come from? Love explains that the federal government spends more than $100 billion each year on pharmaceuticals via the Medicare prescription drug benefit, the Veterans Administration and the federal workers insurance plans. He says the prize plan "would easily pay for itself" with the savings achieved through lower prices for new drugs.
Under the Sanders bill, which Love co-authored, the innovation fund would have a board of trustees determining which innovations deserve prizes. As imagined by Sanders and Love, the board would be comprised of 13 members, including the administrator of the Centers for Medicare and Medicaid, the commissioner of the FDA, the director of the Centers for Disease Control and Prevention, nine presidential appointees (three representatives from the business sector, three private medical researchers, and three consumer advocates).
For every drug approved by the FDA, the board would determine whether and in what amount to award it's designers. Award payments could be staggered over as much as ten years, with no single drug being granted more than 5% (or $4 billion) of the fund in any given year. An 18% portion of each year's fund would be set aside to award research in neglected diseases, AIDS vaccines, and medicines for responding to bioterrorism.
Love's proposal is grand, but he believes that Big Pharma is facing a strong headwind as government grapples with ways to pay for its health programs. "It's either going to be price controls or prizes," he says. "Prizes are more market driven." Clearly, if industry wants to avoid this scenario, they had better start fashioning some new ideas of their own.
What to do about the high cost of drugs? A cadre of academics and economists has a radical new answer: Take away the exclusive product patents the government grants a new drug and replace them with cash awards to the innovating company.
Not surprisingly, this is one prize Big Pharma says it doesn't want. Even so, the idea of "prizes not patents" is gaining support and sparking a heated debate over the price of medical innovation.
Here's how the so-called "prizes not patents" scheme would work, according to its supporters: The federal government would set up an $80 billion innovation fund, and rather than grant exclusive patents, officials would use the pot of cash to reward each company's new drug discovery with a one-time prize. Regulators would then take the new drug's formula and place it in the public domain, where any other drugmaker can copy it, make a duplicate medicine, and rush it to market. The hope is that the ensuing market competition would generate dramatically lower prices for new medications.
Such policy notions would have little traction if not for the overwhelming feeling that drugs are too costly. Drug treatments are becoming an increasingly larger part of the U.S. healthcare budget. And as baby-boomers begin to sign up for Medicare's new prescription drug benefit, taxpayers and politicians are fretting the costs. Americans spent $274 billion on prescription drugs in 2006, an increase of 82% over spending in 2000. Medicine prices have risen faster than the rate of inflation in each year of this decade.
According to a study by the AARP Policy Institute, the average senior citizen taking four brand name medications saw a cumulative increase of $1,461 to fill prescriptions between 2000 and 2006. Reform advocates fear that increasing costs can limit patients' access to life-saving drugs. Some of the most expensive drugs, in fact, are those for cancer treatment.
Moreover, some policymakers believe prizes would solve more than just high prices. They say the plan would create an incentive for companies to research and develop medicines diseases that are more prevalent in developing countries - ailments drugmakers currently considered to be less lucrative.
If the new patent scheme sounds downright Soviet, that's because it is. Actually, the old Soviet Union tried awarding prizes for innovation, but according to most Russian policy experts, the system failed to generate scientific creativity. Supporters of this new plan point out, however, that the Soviet's were too stingy, and didn't offer large enough prizes.
The prize plan is gaining new clout in recent months. Nobel laureate economist Joseph Stiglitz advocated the idea in a recent syndicated column. "[T]he patent system with all of its distortions has failed in so many ways," Stiglitz lamented. Last month, Vermont Senator Bernie Sanders introduced the idea in the form of the Medical Innovation Prize Act of 2007.
Earlier this month on the presidential campaign trail, John Edwards promised to make drug patent reform a part of his healthcare agenda. The former North Carolina senator told a gathering in New Hampshire that the plan would "create a different dynamic for drug companies and particularly for breakthrough drugs in big areas like Alzheimer's, cancer, etc." "We'd offer a cash prize for research and development of these drugs, but they don't the patent," Edwards explained. "So, we eliminate the monopoly."
Big drugmakers shudder at the idea of more government involvement in their business. "A prize system could interrupt the flow of funding needed to guarantee research success and could inject the government into decisions about research priorities," says Ken Johnson, senior vice president of PhRMA, the drug industry's main lobbying organization. Johnson insists out that the current patent system hardly grants the lucrative monopolies critics describe.
While it's true, for instance, that patents last 17.5 years, unlike other industries, drugmakers conduct an average of about 12.5 years of research on medicines before they can gain FDA approval. That leaves roughly five years of patent exclusivity for a drug company to recoup its industry average $800 million investment. "We believe that any weakening of the current patent system could be potentially devastating for patients," Johnson says.
The idea of government prizes for drug innovation is the brainchild of James Love, an economist who is director of Knowledge Ecology International, a Washington, D.C.-based think tank. Love has made a name for himself in the nation's capital as a consumer advocate, lobbying and working to pass legislation in areas including technology, intellectual property and health care. He is often criticized for being anti-business, but he believes his prescription for drug companies couldn't be more pro-industry.
"We're saying we want to give $80 billion a year to biotechs, Big Pharma," says Love. "Is that really anti-business? To me, it's a market-oriented alternative to an unproductive, ethically challenged system. Patients prefer a free market, but they don't like monopolies where you pay $100,000 a year for cancer medicines."
So where does the $80 billion come from? Love explains that the federal government spends more than $100 billion each year on pharmaceuticals via the Medicare prescription drug benefit, the Veterans Administration and the federal workers insurance plans. He says the prize plan "would easily pay for itself" with the savings achieved through lower prices for new drugs.
Under the Sanders bill, which Love co-authored, the innovation fund would have a board of trustees determining which innovations deserve prizes. As imagined by Sanders and Love, the board would be comprised of 13 members, including the administrator of the Centers for Medicare and Medicaid, the commissioner of the FDA, the director of the Centers for Disease Control and Prevention, nine presidential appointees (three representatives from the business sector, three private medical researchers, and three consumer advocates).
For every drug approved by the FDA, the board would determine whether and in what amount to award it's designers. Award payments could be staggered over as much as ten years, with no single drug being granted more than 5% (or $4 billion) of the fund in any given year. An 18% portion of each year's fund would be set aside to award research in neglected diseases, AIDS vaccines, and medicines for responding to bioterrorism.
Love's proposal is grand, but he believes that Big Pharma is facing a strong headwind as government grapples with ways to pay for its health programs. "It's either going to be price controls or prizes," he says. "Prizes are more market driven." Clearly, if industry wants to avoid this scenario, they had better start fashioning some new ideas of their own.
Middle East rising: The Gulf branches out
The $7.5 billion cash injection that Citigroup received from Abu Dhabi's state investment fund has been presented as a vote of confidence in the capital-starved bank, which has suffered heavy losses from subprime lending.
But the deal, which will eventually give the Emirate state an equity stake of as much as 5 percent, is also further evidence that oil-rich Arab countries are succeeding in their strategy to reduce dependence on oil revenue. Paradoxically, while Arab sovereign funds are taking advantage of what appears to be low valuations to snap up shares in international blue chips - like Sony, Carlyle Group and MGM-Mirage - international investors are seizing on growth opportunities in the Middle East. Flows of foreign direct investment have quadrupled since 2002, and are expected to top $80 billion this year, according to the International Monetary Fund.
These are boom times for Middle East stock markets. The MSCI United Arab Emirates domestic benchmark has risen 34 percent since May, while Kuwait's financial market has moved up more than 40 percent over the same period. Even small and relatively illiquid exchanges, like that of Bahrain, have posted double-digit gains in recent months.
International investment powerhouses like Barings, Goldman Sachs, DWS and Allianz Global Investors are stepping up coverage of the 15 markets that make up the Middle East region, with a combined market capitalization of $1 trillion. More and more asset managers are planning, or have already started, Middle East equity funds. Front-runners include T. Rowe Price, JPMorgan and Fidelity Investments.
Haissam Arabi, managing director of Shuaa Asset Management, whose flagship equity investment product is the Arab Gateway fund, suggested that all emerging markets funds should have some exposure to Middle Eastern stock exchanges. "Historically, the region has always had a zero-to-low correlation with the rest of the world, so at the very least the Arab markets are an important diversification tool."
Twelve months ago the investment picture in the Middle East was very different. In 2006, the average Arab stock market lost nearly 50 percent of its value, with many taking much harder hits. Dubai's financial market, for example, plunged 68 percent. Speculative domestic investors drove these markets higher, and when sentiment turned bearish, these same investors took the first opportunity to bail out - a textbook definition of "hot money."
Middle East bulls seem confident in their assertion that enough safeguards are in place to minimize the risk of another major crash. Analysts at Barings and DWS believe the region's stock markets are on an upward trajectory for at least 18 months.
Buoyed by petrodollars, the six Gulf Cooperation Council countries - the United Arab Emirates, Bahrain, Kuwait, Oman, Qatar and Saudi Arabia - are flexing their financial muscle and transforming the region's infrastructure and services. A significant portion of the investment capital is filtering through to the neighboring non-oil producing states of Jordan and Egypt. Lehman Brothers estimates that there are nearly 2,000 projects in progress across the region worth more than $1.3 trillion.
A major area of investment is the power sector, where improvements in generation capacity will require infrastructure spending of $150 billion before 2020, according to the World Energy Council. Companies in banking, transportation, real estate and basic materials are reaping the benefits of this spending splurge, with many posting triple-digit growth rates.
All of this makes fund managers like Nick Price, who manages a Middle East equity fund out of London for Fidelity Investments, extremely optimistic.
"What differs from previous oil booms is that, firstly, the oil price move appears to be secular, driven by Chinese and Indian demand," he said. "Secondly, more money is being recycled into Middle East economies than in the past, which should help diversify the economies."
Claire Simmonds, client portfolio manager for JPMorgan Asset Management in London, agreed with Price that oil was no longer the only factor in the region. "Around 40 percent of the Arab population is under 30 years old, a statistic that will ensure investment in infrastructure and services continues for some time yet," she said.
There are other reasons why investors are prowling for a stake in the Middle East: Arab markets are trading at attractive price-earnings multiples compared with other developing markets. Dubai is trading on a forward price-earnings ratio, or price as a multiple of projected earnings, of 13, compared with 45 in China and 22 in India.
Secondly, the Gulf Cooperation Council currencies are pegged to the U.S. dollar, which means that European and Asian investors can get a lot more for their money at present.
The flip side of any emerging market, though, is lack of control. The price declines in 2005 and 2006 were attributed in part to lax regulation: Companies were investing in one another's shares and pushing up valuations to extraordinary levels. Even assuming safeguards are now in place to prevent another major crash, inflationary pressures could lead to bubbles.
The downside to the dollar peg is that the regional monetary authorities have little leeway with regard to interest rate policy. The rate cuts that the United States initiated recently are stimulating growth in the Middle East region and fueling inflation, at a time when the financial authorities should in fact be tightening monetary policy.
"Yes, inflation is a problem; but any move away from a dollar peg would be gradual and in small increments," Price said. "We are certainly not expecting fireworks." Among Price's stockholdings is Aldar Properties, a real estate company based in Abu Dhabi.
Perhaps the greatest frustration for international investors is a relative lack of choice and access. Gulf markets, which are heavy on property and financial stocks, impose limits on the number of shares foreigners can own.
Not surprisingly, many so-called Middle East funds have to look outside the region for their core holdings. JP Morgan Middle East equity fund has more than 70 percent of its assets in Turkey, Egypt and Israel. Less than 10 percent of the fund is invested in Jordan, the UAE markets and Qatar. Its top ten holdings include Teva Pharmaceuticals, of Israel, Turkiye Is Bankasi and Migros Turk Pharmaceuticals.
T. Rowe Price's Africa and Middle East fund, started in September, has around 20 percent in Gulf markets. Holdings include Gulf Finance House, Commercial Bank of Qatar and Bank Muscat, which is domiciled in Oman. Around 50 percent is invested in Africa.
Emerging-market fund managers with a wider purview sometimes avoid the Gulf altogether. Glen Finegan of First State Investments in London said he was finding enough to buy in more established markets like Turkey and Egypt. "I need very strong reasons to be invested in the Gulf states," he said. "My primary concern is that the performance of these markets may be based on the high oil price rather than strong company fundamentals."
Finegan prefers Turkey because of the Turkish entrepreneurial talent. "Turkish companies run with an idea and make full use of their cultural links to expand into neighboring markets," he said. "I am not getting that sense of dynamism from companies" in the Middle East. Finegan's stock picks include Anadolu EFS, a leading brewer and Coca-Cola bottler in Turkey, and Lecico, an Egyptian company that makes ceramic sanitary ware.
Rather than compete for a shrinking slice of the Middle East pie, Bedlam Asset Management in London has opted to invest in international companies that derive a significant portion of their profits from the region. Ian McCallum, manager of an emerging markets fund for Bedlam, cited Komatsu, which makes and sells mining equipment to companies in the Middle East, and Isuzu Motors.
Investors looking for a pure play on Gulf markets might want to consider a homegrown fund. The National Bank of Abu Dhabi's UAE Growth fund has been going for seven years and is open to international investors.
Following the U.S. rate cuts, David Sanders, the portfolio manager, has bought into companies that stand to benefit from inflation or be unaffected by it. Holdings include Orascom Construction in Egypt; Industries of Qatar, a building materials firm, and Sabic Industries, a Saudi company with interests in petrochemicals, plastics and basic materials. Sanders also holds EtiSalat, an Emirates telecommunications company, and Abu Dhabi's global energy company Taqa - two stocks that outside funds cannot access because of share ownership restrictions.
But the deal, which will eventually give the Emirate state an equity stake of as much as 5 percent, is also further evidence that oil-rich Arab countries are succeeding in their strategy to reduce dependence on oil revenue. Paradoxically, while Arab sovereign funds are taking advantage of what appears to be low valuations to snap up shares in international blue chips - like Sony, Carlyle Group and MGM-Mirage - international investors are seizing on growth opportunities in the Middle East. Flows of foreign direct investment have quadrupled since 2002, and are expected to top $80 billion this year, according to the International Monetary Fund.
These are boom times for Middle East stock markets. The MSCI United Arab Emirates domestic benchmark has risen 34 percent since May, while Kuwait's financial market has moved up more than 40 percent over the same period. Even small and relatively illiquid exchanges, like that of Bahrain, have posted double-digit gains in recent months.
International investment powerhouses like Barings, Goldman Sachs, DWS and Allianz Global Investors are stepping up coverage of the 15 markets that make up the Middle East region, with a combined market capitalization of $1 trillion. More and more asset managers are planning, or have already started, Middle East equity funds. Front-runners include T. Rowe Price, JPMorgan and Fidelity Investments.
Haissam Arabi, managing director of Shuaa Asset Management, whose flagship equity investment product is the Arab Gateway fund, suggested that all emerging markets funds should have some exposure to Middle Eastern stock exchanges. "Historically, the region has always had a zero-to-low correlation with the rest of the world, so at the very least the Arab markets are an important diversification tool."
Twelve months ago the investment picture in the Middle East was very different. In 2006, the average Arab stock market lost nearly 50 percent of its value, with many taking much harder hits. Dubai's financial market, for example, plunged 68 percent. Speculative domestic investors drove these markets higher, and when sentiment turned bearish, these same investors took the first opportunity to bail out - a textbook definition of "hot money."
Middle East bulls seem confident in their assertion that enough safeguards are in place to minimize the risk of another major crash. Analysts at Barings and DWS believe the region's stock markets are on an upward trajectory for at least 18 months.
Buoyed by petrodollars, the six Gulf Cooperation Council countries - the United Arab Emirates, Bahrain, Kuwait, Oman, Qatar and Saudi Arabia - are flexing their financial muscle and transforming the region's infrastructure and services. A significant portion of the investment capital is filtering through to the neighboring non-oil producing states of Jordan and Egypt. Lehman Brothers estimates that there are nearly 2,000 projects in progress across the region worth more than $1.3 trillion.
A major area of investment is the power sector, where improvements in generation capacity will require infrastructure spending of $150 billion before 2020, according to the World Energy Council. Companies in banking, transportation, real estate and basic materials are reaping the benefits of this spending splurge, with many posting triple-digit growth rates.
All of this makes fund managers like Nick Price, who manages a Middle East equity fund out of London for Fidelity Investments, extremely optimistic.
"What differs from previous oil booms is that, firstly, the oil price move appears to be secular, driven by Chinese and Indian demand," he said. "Secondly, more money is being recycled into Middle East economies than in the past, which should help diversify the economies."
Claire Simmonds, client portfolio manager for JPMorgan Asset Management in London, agreed with Price that oil was no longer the only factor in the region. "Around 40 percent of the Arab population is under 30 years old, a statistic that will ensure investment in infrastructure and services continues for some time yet," she said.
There are other reasons why investors are prowling for a stake in the Middle East: Arab markets are trading at attractive price-earnings multiples compared with other developing markets. Dubai is trading on a forward price-earnings ratio, or price as a multiple of projected earnings, of 13, compared with 45 in China and 22 in India.
Secondly, the Gulf Cooperation Council currencies are pegged to the U.S. dollar, which means that European and Asian investors can get a lot more for their money at present.
The flip side of any emerging market, though, is lack of control. The price declines in 2005 and 2006 were attributed in part to lax regulation: Companies were investing in one another's shares and pushing up valuations to extraordinary levels. Even assuming safeguards are now in place to prevent another major crash, inflationary pressures could lead to bubbles.
The downside to the dollar peg is that the regional monetary authorities have little leeway with regard to interest rate policy. The rate cuts that the United States initiated recently are stimulating growth in the Middle East region and fueling inflation, at a time when the financial authorities should in fact be tightening monetary policy.
"Yes, inflation is a problem; but any move away from a dollar peg would be gradual and in small increments," Price said. "We are certainly not expecting fireworks." Among Price's stockholdings is Aldar Properties, a real estate company based in Abu Dhabi.
Perhaps the greatest frustration for international investors is a relative lack of choice and access. Gulf markets, which are heavy on property and financial stocks, impose limits on the number of shares foreigners can own.
Not surprisingly, many so-called Middle East funds have to look outside the region for their core holdings. JP Morgan Middle East equity fund has more than 70 percent of its assets in Turkey, Egypt and Israel. Less than 10 percent of the fund is invested in Jordan, the UAE markets and Qatar. Its top ten holdings include Teva Pharmaceuticals, of Israel, Turkiye Is Bankasi and Migros Turk Pharmaceuticals.
T. Rowe Price's Africa and Middle East fund, started in September, has around 20 percent in Gulf markets. Holdings include Gulf Finance House, Commercial Bank of Qatar and Bank Muscat, which is domiciled in Oman. Around 50 percent is invested in Africa.
Emerging-market fund managers with a wider purview sometimes avoid the Gulf altogether. Glen Finegan of First State Investments in London said he was finding enough to buy in more established markets like Turkey and Egypt. "I need very strong reasons to be invested in the Gulf states," he said. "My primary concern is that the performance of these markets may be based on the high oil price rather than strong company fundamentals."
Finegan prefers Turkey because of the Turkish entrepreneurial talent. "Turkish companies run with an idea and make full use of their cultural links to expand into neighboring markets," he said. "I am not getting that sense of dynamism from companies" in the Middle East. Finegan's stock picks include Anadolu EFS, a leading brewer and Coca-Cola bottler in Turkey, and Lecico, an Egyptian company that makes ceramic sanitary ware.
Rather than compete for a shrinking slice of the Middle East pie, Bedlam Asset Management in London has opted to invest in international companies that derive a significant portion of their profits from the region. Ian McCallum, manager of an emerging markets fund for Bedlam, cited Komatsu, which makes and sells mining equipment to companies in the Middle East, and Isuzu Motors.
Investors looking for a pure play on Gulf markets might want to consider a homegrown fund. The National Bank of Abu Dhabi's UAE Growth fund has been going for seven years and is open to international investors.
Following the U.S. rate cuts, David Sanders, the portfolio manager, has bought into companies that stand to benefit from inflation or be unaffected by it. Holdings include Orascom Construction in Egypt; Industries of Qatar, a building materials firm, and Sabic Industries, a Saudi company with interests in petrochemicals, plastics and basic materials. Sanders also holds EtiSalat, an Emirates telecommunications company, and Abu Dhabi's global energy company Taqa - two stocks that outside funds cannot access because of share ownership restrictions.
As Drybulk Goes, So Goes The World Economy
Shares of drybulk shippers jumped on Friday as the cost of chartering vessels extended its advance, a sign that the global economy -- powered in large part by China -- is expanding at a smart pace.
Drybulk future rates were up about 17% from last week with an average Capesize rate at $137,000 per vessel per day, up from $116,000, said Cantor Fitzgerald analysts. Meanwhile, spot rates for Capesize vessels, which are the largest ships, shot up on Friday to $177,418, up 2.9%, from $172,369 on Thursday, but down slightly from last week. A year ago, however, the rate was below $68,000.
One reason may be that the world’s largest iron ore producer, Brazil’s Companhia Vale do Rio Doce, said on Thursday that it had begun discussions with its customers over iron-ore prices for next year. China is the world’s biggest iron importer, and it gets 24% of its needs from Brazil. Analysts and investors are expecting significant price increases for iron ore in 2008, indicating strong demand. In turn, dry bulk forward rates for 2008 are also showing increases.
On Friday, dry bulk shipping stocks shot up, with those most exposed to the spot market posting the biggest rises.
DryShips, which is heavily exposed to spot rates, saw its shares jump 5.0%, or $4.52, to $94.48 at the close, while Diana Shipping shot up 4.5%, or $1.52, to $35.41. Excel Maritime rose 1.4%, or 76 cents, to $53.54; Quintana Maritime gained 3.1%, or 79 cents, to $26.55; and Euroseas increased 4.0%, or 58 cents, to $15.20.
Dahlman Rose analyst Omar Nokta said China’s demand for ships to deliver steel exports continues to be strong, which proves that the global economy isn’t slowing. “Until we start seeing steel prices ease, things are still very strong,” Nokta said.
Last year at this time, Nokta said, there were also a lot of concerns, but he kept reassuring investors that as long as drybulk stocks were strong the economy was doing fine. “At this moment in time drybulk is still rocking, but it remains to be seen what’s going to happen going forward.”
For now, Chinese demand keeps increasing with projects lined up for next year. “Right now it doesn’t seem like they’ll just go off a cliff,” Nokta said.
The Associated Press contributed to this article.
Drybulk future rates were up about 17% from last week with an average Capesize rate at $137,000 per vessel per day, up from $116,000, said Cantor Fitzgerald analysts. Meanwhile, spot rates for Capesize vessels, which are the largest ships, shot up on Friday to $177,418, up 2.9%, from $172,369 on Thursday, but down slightly from last week. A year ago, however, the rate was below $68,000.
One reason may be that the world’s largest iron ore producer, Brazil’s Companhia Vale do Rio Doce, said on Thursday that it had begun discussions with its customers over iron-ore prices for next year. China is the world’s biggest iron importer, and it gets 24% of its needs from Brazil. Analysts and investors are expecting significant price increases for iron ore in 2008, indicating strong demand. In turn, dry bulk forward rates for 2008 are also showing increases.
On Friday, dry bulk shipping stocks shot up, with those most exposed to the spot market posting the biggest rises.
DryShips, which is heavily exposed to spot rates, saw its shares jump 5.0%, or $4.52, to $94.48 at the close, while Diana Shipping shot up 4.5%, or $1.52, to $35.41. Excel Maritime rose 1.4%, or 76 cents, to $53.54; Quintana Maritime gained 3.1%, or 79 cents, to $26.55; and Euroseas increased 4.0%, or 58 cents, to $15.20.
Dahlman Rose analyst Omar Nokta said China’s demand for ships to deliver steel exports continues to be strong, which proves that the global economy isn’t slowing. “Until we start seeing steel prices ease, things are still very strong,” Nokta said.
Last year at this time, Nokta said, there were also a lot of concerns, but he kept reassuring investors that as long as drybulk stocks were strong the economy was doing fine. “At this moment in time drybulk is still rocking, but it remains to be seen what’s going to happen going forward.”
For now, Chinese demand keeps increasing with projects lined up for next year. “Right now it doesn’t seem like they’ll just go off a cliff,” Nokta said.
The Associated Press contributed to this article.
Wednesday, November 28, 2007
You have to think long term
The WSJ today (D1) is telling yield-hungry bond investors to look at stocks. In the article, they compare the fortunes of someone who invested $1mm in Treasury bills back at the end of 1925 and spent only the income with the fortunes of someone who invested the same $1mm, spending only the income, in large cap stocks.
Let's assume they took the safe route, stashing the entire sum in Treasury bills and then left you to live off the interest. In 2006, your income would have been $48,000versus $33,000 in 1926, according to Ibbotson Associates, a unit of Chicago investment researchers Morningstar. Trouble is, because of inflation, $1 of interest in 2006 had less than a tenth of the spending power of $1 in 1926.
Now, imagine instead that your parents rolled the dice and plunked the $1 million in large‐company stocks. If you spent the dividends but didn't sell any shares, you would have pocketed a robust stream of income that climbed in 65 years and fell in just 15, Ibbotson calculates.
Even more impressive, your $1 million would have ballooned to $111 million over the 81 years ‐‐ and your income would have jumped from $54,000 in 1926 to almost $2 million in 2006. Indeed, your income would have grown at an average 4.6% a year, easily outpacing inflation's 3.1%.
Cash Back
Some U.S. stocks boast higher yields than 10-year Treasury notes.
Dow Jones Industrial Average 2.3%
High-dividend Dow Stocks 4.2%
10-year Treasury notes 3.9%
Let's assume they took the safe route, stashing the entire sum in Treasury bills and then left you to live off the interest. In 2006, your income would have been $48,000versus $33,000 in 1926, according to Ibbotson Associates, a unit of Chicago investment researchers Morningstar. Trouble is, because of inflation, $1 of interest in 2006 had less than a tenth of the spending power of $1 in 1926.
Now, imagine instead that your parents rolled the dice and plunked the $1 million in large‐company stocks. If you spent the dividends but didn't sell any shares, you would have pocketed a robust stream of income that climbed in 65 years and fell in just 15, Ibbotson calculates.
Even more impressive, your $1 million would have ballooned to $111 million over the 81 years ‐‐ and your income would have jumped from $54,000 in 1926 to almost $2 million in 2006. Indeed, your income would have grown at an average 4.6% a year, easily outpacing inflation's 3.1%.
Cash Back
Some U.S. stocks boast higher yields than 10-year Treasury notes.
Dow Jones Industrial Average 2.3%
High-dividend Dow Stocks 4.2%
10-year Treasury notes 3.9%
Tuesday, November 27, 2007
Tax breaks: What the leading candidates are proposing
The presidential front-runners are vying for votes with lots of new ideas, including new incentives to save, invest and buy insurance.
Presidential campaigning is a promise-making fiesta, and never more so than when it comes to taxes.
All of the leading 2008 presidential candidates have proposed new tax breaks. Some are designed to encourage behaviors such as investing in stocks or buying health insurance, or to promote economic growth. Others are offered as ways to make the tax code more fair in the eyes of the candidate.
These breaks will have an effect on federal government coffers, although just how much hasn't been measured yet. In some instances, when one tax break is proposed, it is intended to replace an existing break already on the books.
Below are some of the tax breaks that the presidential front-runners have proposed so far. Not all candidates are equally detailed in their proposals, nor has every candidate weighed in on each tax break listed here.
The front-runners were determined by the results of CNN's most recent national polls in which a candidate got at least 10 percent of the vote. Among the Democrats, they are Hillary Clinton, Barack Obama and John Edwards. From the Republican field, there is Rudy Giuliani, Mitt Romney, Fred Thompson, John McCain and Mike Huckabee.
INVESTMENT TAX BREAKS
One of the most politically divisive tax issues in the presidential campaign is whether to extend President Bush's tax cuts on long-term capital gains and dividends.
Currently they're both taxed at 15 percent (less for low-income taxpayers), and they are scheduled to rise by 2011 to 20 percent for capital gains and to ordinary income tax rates for dividends.
Edwards: Would make the first $250 of interest, capital gains and dividends tax-free for everyone, although he would favor raising the capital gains tax rate to 28 percent for taxpayers making more than $200,000.
Obama: Would eliminate capital gains taxes for business start-ups, although he would favor raising the capital gains tax rate to somewhere between 20 percent and 28 percent for taxpayers making more than $250,000.
Romney: Wants to eliminate the tax on interest, capital gains and dividends for taxpayers with adjusted gross incomes under $200,000, and would make the Bush investment tax cuts permanent for everyone else.
Giuliani, McCain and Thompson: Would make Bush investment tax cuts permanent.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no investment taxes.
SAVINGS TAX BREAKS
Using the tax code to encourage retirement and other types of savings has a long history, and it's one which at least three of the candidates would like to continue.
Clinton: Would expand the current savers' credit, which currently only goes to low-income taxpayers saving for retirement. She wants to offer a 100 percent matching tax credit for the first $1,000 saved for retirement by married couples making less than $60,000, and a 50 percent matching credit for couples making between $60,000 and $100,000. The credit - which is a dollar-for-dollar reduction of one's tax bill - would be refundable, meaning couples would receive it as a refund if they don't have enough of a tax bill to offset with the credit.
Edwards: Would expand the savers' credit. He would offer a refundable tax credit up to $500 a year in savings for families with incomes under $75,000. Currently you may qualify for an income tax credit up to $2,000 in retirement savings if your adjusted gross income is $25,000 or less ($50,000 or less if you're married filing jointly).
Edwards' tax credit wouldn't be limited to retirement savings, but could apply to savings for college, for a down payment, for starting a small business or for financial emergencies.
He also would offer low-income families an additional $500 refundable tax credit for savings. Additionally, he would allow families to deposit their child tax credits into tax-free savings accounts.
Giuliani: Has said he would expand tax-free savings accounts but offered no details.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no taxes on your savings.
MORTGAGE TAX BREAKS
Currently, you are allowed to deduct the interest you pay on your mortgage if you itemize your deductions. But since only about a third of taxpayers itemize, homeowners who take the standard deduction don't receive an additional tax break for owning a home the way itemizers do.
Obama: Would create a refundable tax credit equal to 10 percent of mortgage interest. The credit would be available to any taxpayer who has a mortgage and does not itemize their deductions. The addition of a credit means you would get a break on your mortgage interest even if you take the standard deduction. It would be in addition to, rather than instead of, the mortgage interest deduction.
HEALTH INSURANCE TAX BREAKS
All the front-runners have proposed reforming healthcare or at least making some change to the way health insurance is provided. Creating new tax incentives is one piece of their plans to make health insurance more affordable, encourage people to buy it and to encourage them to be more cost-conscious about medical expenses.
Currently, the portion of your premiums paid by your employer on your behalf is excluded from your gross income, meaning it is tax-free compensation to you. If you're buying health insurance on your own, you get no tax breaks for the premiums you pay.
Clinton: Wants to create health care tax credits for small businesses and a refundable "premium affordability" tax credit for individuals buying health insurance so that their premiums never exceed a certain percentage of family income.
Edwards: Has proposed creating a "health care market" of regional, non-profit purchasing pools that offer competing health insurance plans to companies without plans of their own and to individuals who don't have access to a plan at work or through public programs.
Edwards would offer a new tax credit for middle- and lower-income people who buy insurance through a Health Care Market. The amount of the credit would be determined by an income-based sliding scale and the credit would be refundable for those who don't have any income tax liability.
Giuliani: Would allow people who can't get insurance from their employers to exclude from their gross income up to $7,500 in health insurance costs for singles ($15,000 for families) if they buy health insurance on their own.
He also has proposed a separate health insurance credit for low-income Americans.
McCain: Would offer a refundable tax credit of $2,500 ($5,000 for families) to anyone who buys health insurance, whether through an employer or not. That credit would replace the tax-free nature of the portion of your premiums paid by your employer, which would become taxable income to you.
If your policy costs less than the value of the credit, you can deposit the remainder in a health savings account (HSA). HSAs let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Romney: Has said he supports the deductibility of medical expenses, including the cost of health insurance and out-of-pocket expenses for anyone who has a plan that at least provides catastrophic insurance.
He also has called for an expansion of HSAs, which let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Huckabee: Has said he would make HSAs available to everyone, not just those with high-deductible plans. HSAs let you save tax-free for medical expenses.
He prefers to move away from the employer-based system for insurance, but would offer taxpayers a deduction for the health insurance premiums they pay. For low-income taxpayers, they would get a credit instead. A credit is a dollar-for-dollar reduction of taxes you owe, whereas a deduction reduces your taxes by a percentage equal to your top income tax rate.
ESTATE TAX BREAKS
Currently estates worth up to $2 million are exempt from the estate tax. That exemption level will rise to $3.5 million by 2009. In 2010, the estate tax is scheduled to be repealed entirely for one year and then it will be reinstated in 2011 at a $1 million exemption level. The current top tax rate on estates is 45 percent. By 2011, it will increase to 55 percent.
Clinton: Would increase the estate tax exemption level to $3.5 million.
Edwards: Would raise the exemption level to $4 million.
Romney, Giuliani and Thompson: Would eliminate the estate tax.
McCain: Would increase the exemption level to $10 million and tax the portion of an estate above $10 million at a flat 15 percent.
Presidential campaigning is a promise-making fiesta, and never more so than when it comes to taxes.
All of the leading 2008 presidential candidates have proposed new tax breaks. Some are designed to encourage behaviors such as investing in stocks or buying health insurance, or to promote economic growth. Others are offered as ways to make the tax code more fair in the eyes of the candidate.
These breaks will have an effect on federal government coffers, although just how much hasn't been measured yet. In some instances, when one tax break is proposed, it is intended to replace an existing break already on the books.
Below are some of the tax breaks that the presidential front-runners have proposed so far. Not all candidates are equally detailed in their proposals, nor has every candidate weighed in on each tax break listed here.
The front-runners were determined by the results of CNN's most recent national polls in which a candidate got at least 10 percent of the vote. Among the Democrats, they are Hillary Clinton, Barack Obama and John Edwards. From the Republican field, there is Rudy Giuliani, Mitt Romney, Fred Thompson, John McCain and Mike Huckabee.
INVESTMENT TAX BREAKS
One of the most politically divisive tax issues in the presidential campaign is whether to extend President Bush's tax cuts on long-term capital gains and dividends.
Currently they're both taxed at 15 percent (less for low-income taxpayers), and they are scheduled to rise by 2011 to 20 percent for capital gains and to ordinary income tax rates for dividends.
Edwards: Would make the first $250 of interest, capital gains and dividends tax-free for everyone, although he would favor raising the capital gains tax rate to 28 percent for taxpayers making more than $200,000.
Obama: Would eliminate capital gains taxes for business start-ups, although he would favor raising the capital gains tax rate to somewhere between 20 percent and 28 percent for taxpayers making more than $250,000.
Romney: Wants to eliminate the tax on interest, capital gains and dividends for taxpayers with adjusted gross incomes under $200,000, and would make the Bush investment tax cuts permanent for everyone else.
Giuliani, McCain and Thompson: Would make Bush investment tax cuts permanent.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no investment taxes.
SAVINGS TAX BREAKS
Using the tax code to encourage retirement and other types of savings has a long history, and it's one which at least three of the candidates would like to continue.
Clinton: Would expand the current savers' credit, which currently only goes to low-income taxpayers saving for retirement. She wants to offer a 100 percent matching tax credit for the first $1,000 saved for retirement by married couples making less than $60,000, and a 50 percent matching credit for couples making between $60,000 and $100,000. The credit - which is a dollar-for-dollar reduction of one's tax bill - would be refundable, meaning couples would receive it as a refund if they don't have enough of a tax bill to offset with the credit.
Edwards: Would expand the savers' credit. He would offer a refundable tax credit up to $500 a year in savings for families with incomes under $75,000. Currently you may qualify for an income tax credit up to $2,000 in retirement savings if your adjusted gross income is $25,000 or less ($50,000 or less if you're married filing jointly).
Edwards' tax credit wouldn't be limited to retirement savings, but could apply to savings for college, for a down payment, for starting a small business or for financial emergencies.
He also would offer low-income families an additional $500 refundable tax credit for savings. Additionally, he would allow families to deposit their child tax credits into tax-free savings accounts.
Giuliani: Has said he would expand tax-free savings accounts but offered no details.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no taxes on your savings.
MORTGAGE TAX BREAKS
Currently, you are allowed to deduct the interest you pay on your mortgage if you itemize your deductions. But since only about a third of taxpayers itemize, homeowners who take the standard deduction don't receive an additional tax break for owning a home the way itemizers do.
Obama: Would create a refundable tax credit equal to 10 percent of mortgage interest. The credit would be available to any taxpayer who has a mortgage and does not itemize their deductions. The addition of a credit means you would get a break on your mortgage interest even if you take the standard deduction. It would be in addition to, rather than instead of, the mortgage interest deduction.
HEALTH INSURANCE TAX BREAKS
All the front-runners have proposed reforming healthcare or at least making some change to the way health insurance is provided. Creating new tax incentives is one piece of their plans to make health insurance more affordable, encourage people to buy it and to encourage them to be more cost-conscious about medical expenses.
Currently, the portion of your premiums paid by your employer on your behalf is excluded from your gross income, meaning it is tax-free compensation to you. If you're buying health insurance on your own, you get no tax breaks for the premiums you pay.
Clinton: Wants to create health care tax credits for small businesses and a refundable "premium affordability" tax credit for individuals buying health insurance so that their premiums never exceed a certain percentage of family income.
Edwards: Has proposed creating a "health care market" of regional, non-profit purchasing pools that offer competing health insurance plans to companies without plans of their own and to individuals who don't have access to a plan at work or through public programs.
Edwards would offer a new tax credit for middle- and lower-income people who buy insurance through a Health Care Market. The amount of the credit would be determined by an income-based sliding scale and the credit would be refundable for those who don't have any income tax liability.
Giuliani: Would allow people who can't get insurance from their employers to exclude from their gross income up to $7,500 in health insurance costs for singles ($15,000 for families) if they buy health insurance on their own.
He also has proposed a separate health insurance credit for low-income Americans.
McCain: Would offer a refundable tax credit of $2,500 ($5,000 for families) to anyone who buys health insurance, whether through an employer or not. That credit would replace the tax-free nature of the portion of your premiums paid by your employer, which would become taxable income to you.
If your policy costs less than the value of the credit, you can deposit the remainder in a health savings account (HSA). HSAs let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Romney: Has said he supports the deductibility of medical expenses, including the cost of health insurance and out-of-pocket expenses for anyone who has a plan that at least provides catastrophic insurance.
He also has called for an expansion of HSAs, which let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Huckabee: Has said he would make HSAs available to everyone, not just those with high-deductible plans. HSAs let you save tax-free for medical expenses.
He prefers to move away from the employer-based system for insurance, but would offer taxpayers a deduction for the health insurance premiums they pay. For low-income taxpayers, they would get a credit instead. A credit is a dollar-for-dollar reduction of taxes you owe, whereas a deduction reduces your taxes by a percentage equal to your top income tax rate.
ESTATE TAX BREAKS
Currently estates worth up to $2 million are exempt from the estate tax. That exemption level will rise to $3.5 million by 2009. In 2010, the estate tax is scheduled to be repealed entirely for one year and then it will be reinstated in 2011 at a $1 million exemption level. The current top tax rate on estates is 45 percent. By 2011, it will increase to 55 percent.
Clinton: Would increase the estate tax exemption level to $3.5 million.
Edwards: Would raise the exemption level to $4 million.
Romney, Giuliani and Thompson: Would eliminate the estate tax.
McCain: Would increase the exemption level to $10 million and tax the portion of an estate above $10 million at a flat 15 percent.
Wish we had thought of that...
Low-risk trades put all others in the shade
Within the hedge fund industry there are some trades that are destined to live on in legend: Jessie Livermore’s claimed $100m profit from shorting the 1929 crash, Paul Tudor Jones’ prediction of the 1987 crash, from which he doubled his money in a month, or the $1bn profit George Soros reputedly made when sterling was forced out of the exchange rate mechanism.
But the forecast last year by a select group of hedge funds of a crisis in subprime mortgages has put even the most spectacular trades in history in the shade.
EDITOR’S CHOICE
1000% hedge fund wins subprime bet - Nov-25
One hedge fund in 10 to go bust, says Man - Nov-20
View from the Top: Peter Clarke - Nov-20
Hedge funds on new ground - Nov-20
Jabre raising second hedge fund - Nov-05
Hedge funds home in on UK targets - Nov-05
Leading the pack of hedge funds which benefited from the subprime fallout is John Paulson’s New York-based Paulson & Co. Last year, it raised $2bn for two funds betting on falls in subprime mortgage-linked securities and they are now worth more than $8bn. By the end of October, the first of these funds was up 550.8 per cent, even after fees which included a quarter of profits.
His merger and event arbitrage funds – which would normally make bets on takeovers and other corporate deals – have also taken positions in subprime-linked securities.
Three of these funds more than doubled investors’ money with their short positions, and investors say that in total, Paulson funds have made more than $12bn from the subprime bet.
“There’s never been a trade of this size of profit ever in the history of financial markets,” says Arki Busson, chairman of EIM Group, which has $13bn invested in hedge funds.
As a result, Mr Paulson is likely to be the highest-paid hedge fund manager of all time when the performance fees crystallise, taking profits estimated by his own investors at between $2bn and $4bn. That would be enough to buy himself 18,000 Bentley Continentals, the hedge fund motor of choice.
“He’s really made a lot of money out of what has in essence been quite a conservative bet,” says one of Mr Paulson’s investors. “There’s no doubt it’s been one of the greatest trades of all time.”
When Mr Paulson was raising money for his new funds last summer, he claimed that “in his entire career he’s never seen such a big opportunity”, another investor says.
It is argued that Paulson has generated these enormous returns from taking relatively little risk.
Houston-based Centaurus Energy, for example, is reported to have made 317 per cent (before fees) last year by betting the opposite way on natural gas prices to that predicted by Amaranth, which collapsed after losing more than $6bn in a week. And Red Kite, the London hedge fund, made more than 250 per cent last year in its metals fund thanks to a successful highly-geared bet on copper prices.
Kyle Bass, who runs Hayman Capital, a Texas hedge fund, says the short credit trade is “by far the best risk/reward position I have ever seen”. A fund Hayman runs jointly with Corriente Advisors was up 526.5 per cent for the year to October, according to letters to investors.
All the short funds are likely to have made significant further gains this month as the credit squeeze caused subprime-linked bonds to lurch further down. An index which tracks these bonds, the ABX index of BBB credits issued in the first half of last year, has plummeted from above 40 to 25 this month, indicating big profits from those using derivatives to take short positions.
Andrew Lahde’s California-based Lahde Capital, for example, has gained about 40 per cent this month, to become the first of the group to pass 1,000 per cent return this year.
However, there may be little further money to make from the trade. Lahde has already begun to return cash to investors, while at the end of September Paulson told investors it saw only a further 30-40 per cent to make from shorting – and it made almost 22 per cent in October alone.
Paulson said then that it was still too early to start buying mortgage exposure, but that when the time came Paulson’s accumulated expertise in the 18,000 individual securities in the market should make it “uniquely positioned to benefit from future long opportunities”.
Some point out that there was widespread concern about subprime quality before the collapse, so the prediction of trouble was not difficult.
“In terms of monetising a trade it is potentially one of the successful trades of all time,” says Neil Meadows, head of fixed income and macro research at New Finance Capital, which has $5.5bn invested in hedge funds.
“But in terms of the intellectual capacity of it, I don’t think it was so hard – everyone knew it was coming. Perhaps not the scale of it or the timing, but they knew it was coming.”
Mr Busson, whose EIM group has money with Paulson, disagrees. He says the skill comes not only in predicting the crisis, but also in the execution of the trades. Mr Paulson – along with several other managers – constructed complex portfolios of the assets they believed would be worst-hit, rather than just shorting an index.
“[Mr Paulson] has always been a very professional hard-working research-oriented guy. With all these great trades, there’s no secret – you need to do an enormous amount of homework.”
Within the hedge fund industry there are some trades that are destined to live on in legend: Jessie Livermore’s claimed $100m profit from shorting the 1929 crash, Paul Tudor Jones’ prediction of the 1987 crash, from which he doubled his money in a month, or the $1bn profit George Soros reputedly made when sterling was forced out of the exchange rate mechanism.
But the forecast last year by a select group of hedge funds of a crisis in subprime mortgages has put even the most spectacular trades in history in the shade.
EDITOR’S CHOICE
1000% hedge fund wins subprime bet - Nov-25
One hedge fund in 10 to go bust, says Man - Nov-20
View from the Top: Peter Clarke - Nov-20
Hedge funds on new ground - Nov-20
Jabre raising second hedge fund - Nov-05
Hedge funds home in on UK targets - Nov-05
Leading the pack of hedge funds which benefited from the subprime fallout is John Paulson’s New York-based Paulson & Co. Last year, it raised $2bn for two funds betting on falls in subprime mortgage-linked securities and they are now worth more than $8bn. By the end of October, the first of these funds was up 550.8 per cent, even after fees which included a quarter of profits.
His merger and event arbitrage funds – which would normally make bets on takeovers and other corporate deals – have also taken positions in subprime-linked securities.
Three of these funds more than doubled investors’ money with their short positions, and investors say that in total, Paulson funds have made more than $12bn from the subprime bet.
“There’s never been a trade of this size of profit ever in the history of financial markets,” says Arki Busson, chairman of EIM Group, which has $13bn invested in hedge funds.
As a result, Mr Paulson is likely to be the highest-paid hedge fund manager of all time when the performance fees crystallise, taking profits estimated by his own investors at between $2bn and $4bn. That would be enough to buy himself 18,000 Bentley Continentals, the hedge fund motor of choice.
“He’s really made a lot of money out of what has in essence been quite a conservative bet,” says one of Mr Paulson’s investors. “There’s no doubt it’s been one of the greatest trades of all time.”
When Mr Paulson was raising money for his new funds last summer, he claimed that “in his entire career he’s never seen such a big opportunity”, another investor says.
It is argued that Paulson has generated these enormous returns from taking relatively little risk.
Houston-based Centaurus Energy, for example, is reported to have made 317 per cent (before fees) last year by betting the opposite way on natural gas prices to that predicted by Amaranth, which collapsed after losing more than $6bn in a week. And Red Kite, the London hedge fund, made more than 250 per cent last year in its metals fund thanks to a successful highly-geared bet on copper prices.
Kyle Bass, who runs Hayman Capital, a Texas hedge fund, says the short credit trade is “by far the best risk/reward position I have ever seen”. A fund Hayman runs jointly with Corriente Advisors was up 526.5 per cent for the year to October, according to letters to investors.
All the short funds are likely to have made significant further gains this month as the credit squeeze caused subprime-linked bonds to lurch further down. An index which tracks these bonds, the ABX index of BBB credits issued in the first half of last year, has plummeted from above 40 to 25 this month, indicating big profits from those using derivatives to take short positions.
Andrew Lahde’s California-based Lahde Capital, for example, has gained about 40 per cent this month, to become the first of the group to pass 1,000 per cent return this year.
However, there may be little further money to make from the trade. Lahde has already begun to return cash to investors, while at the end of September Paulson told investors it saw only a further 30-40 per cent to make from shorting – and it made almost 22 per cent in October alone.
Paulson said then that it was still too early to start buying mortgage exposure, but that when the time came Paulson’s accumulated expertise in the 18,000 individual securities in the market should make it “uniquely positioned to benefit from future long opportunities”.
Some point out that there was widespread concern about subprime quality before the collapse, so the prediction of trouble was not difficult.
“In terms of monetising a trade it is potentially one of the successful trades of all time,” says Neil Meadows, head of fixed income and macro research at New Finance Capital, which has $5.5bn invested in hedge funds.
“But in terms of the intellectual capacity of it, I don’t think it was so hard – everyone knew it was coming. Perhaps not the scale of it or the timing, but they knew it was coming.”
Mr Busson, whose EIM group has money with Paulson, disagrees. He says the skill comes not only in predicting the crisis, but also in the execution of the trades. Mr Paulson – along with several other managers – constructed complex portfolios of the assets they believed would be worst-hit, rather than just shorting an index.
“[Mr Paulson] has always been a very professional hard-working research-oriented guy. With all these great trades, there’s no secret – you need to do an enormous amount of homework.”
Monday, November 26, 2007
The Fed announced today intentions to pump in liquidity
In response to heightened pressures in the money markets for funding through year‐end the NY Fed announced this morning that it will be pumping in liquidity into the money markets via a series of overlapping long term repo agreements that will extend into year‐end. They pre‐announced the first repo operation that will take place on Wednesday, November 28th and mature on January 10, 2008 for an amount of $8billion. The timing and amounts of subsequent term operations spanning the year‐end will be influenced by market and reserve developments according to the Fed. Ultimately the goal of the Fed is to provide sufficient reserves into the system to resist upward pressure on the Fed funds rae that would drive it up above the Fed target rate. However, as we have seen just recently at the end of this summer into September, the Fed is likely to err on the side of adding too much reserves and we could see the effective Fed funds rate trade below thetarget.
Wednesday, November 21, 2007
Is the U.S. economy melting down?
Whether the Federal Reserve realizes it or not, the United States economy is reeling from a one-two punch of plunging real estate values and a full-blown credit crunch that might not be alleviated with additional rate cuts.
While the Fed might have had a role in creating what has come to be known as the subprime mess, because of the way it has evolved, the Fed's ability to deal with it is rather limited. There are a number of reasons for this.
First and foremost is the fact that, on the real estate side, the damage has already been done. Because short-term interest rates today are well above the 45-year lows plumbed from the middle of 2003 through mid-2004, those mortgages with adjustable rates have or will reset to much higher rates even if the Fed decides to lower rates by a quarter of a point or even more.
As a consequence, there will likely be more delinquencies and foreclosures, which, besides causing pain for those homeowners, will result in more homes on the market, thereby depressing their prices.
In turn, this will affect other homeowners, even those with fixed rate mortgages and who and are current with their payments. They will likely be unable to use their homes as ATMs, tapping the equity to supplement their incomes.
They can't turn to savings, either, since, collectively, the nation's homeowners have been spending more than they have been earning for the past two years. The last time this happened was at the bottom of the Great Depression.
This alone is why consumers are reducing their outlays on all kinds of goods and services -- luxuries and necessities alike. Indeed, you know there's a problem out there when Starbucks reports a decline in traffic in response to, among other reasons, a 9 cent hike in the price of a cup of coffee.
Another reason why the Fed alone will not be able to ameliorate this crisis is that its main jurisdiction is over the banks, and the problem is now centered in the financial markets. This is because the banks no longer have these loans on their books, having turned them into securities and sold them to others.
In turn, these mortgage-backed securities were used as collateral for the issuance of debt, whose value, as you know, is far lower than originally thought. This has caused massive write downs by holders of these securities, cutting into their profits, but more importantly, depleting confidence in the financial system. And this reduction in confidence is spreading beyond the financial markets and residential real estate to commercial real estate as well.
To the extent the banks are involved (by holding on to some of these securities), their capital is being reduced and thus their ability to make new loans.
we need not remind you that the ability to borrow money is the lifeblood of not just business, but consumers, too.
Not surprisingly, the combination of lower real estate values and reduced availability of funding is beginning to reduce business spending on new plants and equipment. This is overwhelming the positive effect that the lower-valued dollar is having on our exports.
So while the Fed is preoccupied with communications and forecasting, the financial markets remain frozen while the economy is melting down.
While the Fed might have had a role in creating what has come to be known as the subprime mess, because of the way it has evolved, the Fed's ability to deal with it is rather limited. There are a number of reasons for this.
First and foremost is the fact that, on the real estate side, the damage has already been done. Because short-term interest rates today are well above the 45-year lows plumbed from the middle of 2003 through mid-2004, those mortgages with adjustable rates have or will reset to much higher rates even if the Fed decides to lower rates by a quarter of a point or even more.
As a consequence, there will likely be more delinquencies and foreclosures, which, besides causing pain for those homeowners, will result in more homes on the market, thereby depressing their prices.
In turn, this will affect other homeowners, even those with fixed rate mortgages and who and are current with their payments. They will likely be unable to use their homes as ATMs, tapping the equity to supplement their incomes.
They can't turn to savings, either, since, collectively, the nation's homeowners have been spending more than they have been earning for the past two years. The last time this happened was at the bottom of the Great Depression.
This alone is why consumers are reducing their outlays on all kinds of goods and services -- luxuries and necessities alike. Indeed, you know there's a problem out there when Starbucks reports a decline in traffic in response to, among other reasons, a 9 cent hike in the price of a cup of coffee.
Another reason why the Fed alone will not be able to ameliorate this crisis is that its main jurisdiction is over the banks, and the problem is now centered in the financial markets. This is because the banks no longer have these loans on their books, having turned them into securities and sold them to others.
In turn, these mortgage-backed securities were used as collateral for the issuance of debt, whose value, as you know, is far lower than originally thought. This has caused massive write downs by holders of these securities, cutting into their profits, but more importantly, depleting confidence in the financial system. And this reduction in confidence is spreading beyond the financial markets and residential real estate to commercial real estate as well.
To the extent the banks are involved (by holding on to some of these securities), their capital is being reduced and thus their ability to make new loans.
we need not remind you that the ability to borrow money is the lifeblood of not just business, but consumers, too.
Not surprisingly, the combination of lower real estate values and reduced availability of funding is beginning to reduce business spending on new plants and equipment. This is overwhelming the positive effect that the lower-valued dollar is having on our exports.
So while the Fed is preoccupied with communications and forecasting, the financial markets remain frozen while the economy is melting down.
Thursday, November 15, 2007
What's sinking the dollar?
Things do tend to go to hell all at once, so maybe it should be no surprise that the dollar tanked as the subprime mess was getting rapidly worse and stock markets were whipsawing, mostly downward.
The dollar's fate is especially worrisome because of its historic role as the world's reserve currency and its obvious importance to the world's largest economy. In today's interconnected global markets the dollar's movements are part cause, part effect -- but on net it's hard to see the dollar getting much stronger anytime soon.
The forces behind the dollar's weakening have been building for years but didn't have much effect until recently.
Most fundamentally, we Americans have been living beyond our means, buying more from the rest of the world than the world buys from us (that's the trade deficit); to do that, we have to give foreigners claims on our assets in the form of government bonds and corporate bonds, or sometimes the assets themselves.
A country as rich as America can do that for a long time, but eventually the world ends up holding more dollars than there is dollar-denominated stuff they want to buy, so they start offloading dollars. They also worry that any country with loads of debt -- even the U.S. -- may be tempted to inflate its currency, and that fear reduces its value.
Since the U.S. has been running huge trade deficits the past several years -- about $700 billion this year -- the stage has long been set for the dollar to drop. What shoved it over the edge was the subprime mess and worries about a U.S. economic downturn. If the economy looks to be slowing down, investors bail out of U.S. assets and turn to investments that must be bought with other currencies. When the Fed tries to perk up the economy by cutting interest rates, as it has done twice recently, it makes the dollar even less attractive because investors can get better rates in other currencies, such as the euro.
What makes investors really nervous is that the trend could become self-reinforcing. A Chinese government official sparked a particularly sharp selloff of the dollar when he said his government would be moving its reserves out of weak currencies and into strong ones -- goodbye, dollar; hello, euro. Since China holds more than $1 trillion, its actions could move markets, pushing the dollar down further, prompting dollar holders to shift out of it further, and so on.
Even if we avoid that scenario, more dollar weakness is probably ahead, at least relative to China's yuan and other currencies of developing nations. As Alan Greenspan points out, when their living standards are rising faster than ours, their currencies will probably appreciate vs. ours. Remember, he says, that the Japanese yen was once 300 to the dollar and eventually strengthened to below 100 (it's now around 113). The trend continues: In just the past year the dollar has weakened 13% vs. the Indian rupee and 11% vs. the Colombian peso, for example.
By the way, Warren Buffett told us all this would happen. In mid 2002, for the first time in his life, he began buying foreign currencies, thus betting against the dollar. He explained his reasons most extensively in a Fortune article he wrote (Nov. 10, 2003). The main factor he cited, the trade deficit, is much worse now. For a year or two after the article, his bet seemed to be a loser. But now, as usual, he looks prescient. To top of page
The dollar's fate is especially worrisome because of its historic role as the world's reserve currency and its obvious importance to the world's largest economy. In today's interconnected global markets the dollar's movements are part cause, part effect -- but on net it's hard to see the dollar getting much stronger anytime soon.
The forces behind the dollar's weakening have been building for years but didn't have much effect until recently.
Most fundamentally, we Americans have been living beyond our means, buying more from the rest of the world than the world buys from us (that's the trade deficit); to do that, we have to give foreigners claims on our assets in the form of government bonds and corporate bonds, or sometimes the assets themselves.
A country as rich as America can do that for a long time, but eventually the world ends up holding more dollars than there is dollar-denominated stuff they want to buy, so they start offloading dollars. They also worry that any country with loads of debt -- even the U.S. -- may be tempted to inflate its currency, and that fear reduces its value.
Since the U.S. has been running huge trade deficits the past several years -- about $700 billion this year -- the stage has long been set for the dollar to drop. What shoved it over the edge was the subprime mess and worries about a U.S. economic downturn. If the economy looks to be slowing down, investors bail out of U.S. assets and turn to investments that must be bought with other currencies. When the Fed tries to perk up the economy by cutting interest rates, as it has done twice recently, it makes the dollar even less attractive because investors can get better rates in other currencies, such as the euro.
What makes investors really nervous is that the trend could become self-reinforcing. A Chinese government official sparked a particularly sharp selloff of the dollar when he said his government would be moving its reserves out of weak currencies and into strong ones -- goodbye, dollar; hello, euro. Since China holds more than $1 trillion, its actions could move markets, pushing the dollar down further, prompting dollar holders to shift out of it further, and so on.
Even if we avoid that scenario, more dollar weakness is probably ahead, at least relative to China's yuan and other currencies of developing nations. As Alan Greenspan points out, when their living standards are rising faster than ours, their currencies will probably appreciate vs. ours. Remember, he says, that the Japanese yen was once 300 to the dollar and eventually strengthened to below 100 (it's now around 113). The trend continues: In just the past year the dollar has weakened 13% vs. the Indian rupee and 11% vs. the Colombian peso, for example.
By the way, Warren Buffett told us all this would happen. In mid 2002, for the first time in his life, he began buying foreign currencies, thus betting against the dollar. He explained his reasons most extensively in a Fortune article he wrote (Nov. 10, 2003). The main factor he cited, the trade deficit, is much worse now. For a year or two after the article, his bet seemed to be a loser. But now, as usual, he looks prescient. To top of page
Boo-yah this: 'Lazy Portfolios' beat 'Mad Money'
Why waste 15 hours a week and lose a $72,000 'opportunity cost?
By Paul B. Farrell
This column, originally published Nov. 6, has been updated with a link to Jim Cramer's response.
ARROYO GRANDE, Calif. -- Last week I finally listened to the "Mad Money" show for a full hour. When channel surfing in the past I'd move on after 30 seconds. It's about as educational as Saturday morning cartoons. What I heard was a manic distraction for addicted personalities. But there I was, alone in the car on a five-hour trip back home. So I made a conscious decision to listen to the entire show, first time (and last!). "Oh god, what torture," I screamed aloud somewhere near Gilroy, the garlic capital of the world: "This is crazy-making, what a waste of time!"
Of course that was the voice of passive investors coming out from deep within my soul, speaking for the 90 million American investors who don't have the time to waste watching this inane "entertainment" program that's brainwashing innocent minds, repeating the dot-com drumbeat of the late 1990s. Seriously, most folks have real jobs that take up most of their time, real families, real outside interests, real lives to live.
Fortunately many Americans have figured out that active trading is a dead-end street. Remember University of California-Davis finance Profs. Terry Odean and Brad Barber and their famous study of 66,400 accounts at a major Wall Street brokerage? They concluded that transaction costs, fees and taxes ate much of the pretax returns: "The more you trade the less you earn." Active traders actually made a third less than passive buy-and-holders. And it's still true.
OK, assuming you're one of America's 2 million to 5 million fairly active traders, calm down. I know you're dismissing what I said. But stick with me for a minute. Take a deep breath before you fire off a nasty email. Quash those emotions and let's look at this another way.
Figure your 'opportunity cost' of trading
You already know that the Odean and Barber research tells us that traders are running the race with a huge handicap. So, let's quantify traders' "opportunity cost," the "economic cost of an opportunity foregone" when they spend time playing by "Mad Money" rules (or any other trading game). In short, what's your time worth if you watch "Mad Money" daily and do the "homework" Cramer recommends?
Jim Cramer's a brilliant trader. I interviewed him in the late 1990s when he was a hedge fund manager. He didn't like my criticism of the Mutual Fund Derby Race on TheStreet.com, of which he was one of the founders. Said I was "over the top." That was at a time when a competing dart-throwing chimpanzee's index called Monkeydex was beating America's top funds.
The fact is, what was "over the top" was TheStreet's manic racetrack imagery that encouraged passive investors to start trading funds, only to rue the day a couple years later when the market tanked and lost $8 trillion in a three-year bear/recession. That was bad media. And last week's "Mad Money" program is the same kind of subtle brainwashing that's misleading passive investors unconsciously into high-risk trading.
Work the numbers. Cramer's emphatic: "Do your homework, the right homework." That can mean many things, depending on your approach to stock research. But one thing's certain, Cramer says: "Doing homework could take as much as an hour per week per position."
But when he says that to investors, "they look at me as if I am some kind of old-fashioned teacher who is asking for way too much in this busy world in which we live. That's just plain wrong."
Good advice. But the one hour daily "Mad Money" show is such a manic wisecracking racetrack mentality with funny costumes, bizarre sound effects and boo-yah cheers that it totally undercuts the subtlety of doing passive "homework." It's more like a hard-sell infomercial to get you to buy a trading system "guaranteed to make you a successful trader."
Except "Mad Money" is drawing people into a new 2007 Derby Race, targeting traders with the minds of kids chasing instant gratification. Read Jim Cramer's response.
'Mad Money's' wasted 'opportunity cost' Here's the hard facts folks: How to quantify the economic "opportunity cost" of the "Mad Money" game. Cramer's right, you must do serious analysis of your "positions." OK, so for five hours a week he overwhelms your mind with tons of opportunities. Let's say that somehow, when the smoke clears, you have 10 "positions."
Now let's do the math in this simple economic equation: If you're following Prof. Cramer's rules and doing your "homework" you're watching "Mad Money" five hours a week and doing another 10 hours of "homework" on your "positions." That's potentially 60 hours of your valuable time each month, on top of your full-time job. Assuming you're a professional or business executive, let's say your time's worth $100 per hour, probably more.
So, bottom line: Your economic "opportunity lost" for 60 hours is at least $6,000 a month or $72,000 a year, playing by "Mad Money" rules. Get it folks? Your time is valuable. If you're worth a minimum of $100 an hour and you spend 60 hours a week on any activity, you darn well better be earning at least $72,000 a year. And to make that kind of money at, say, 15% a year you'd need more than $400,000 capital at risk.
My guess is that most of the "Mad Money" audience takes the easy route: They just go emotionally gaga over some of Cramer's manic stock picking and buy some, without doing the necessary hours of "homework."
'Lazy portfolios' outperform 'Mad Money'
The vast majority of American investors, probably 95%, will likely never waste their valuable time playing "Mad Money's" new Racing Derby, watching and doing all the necessary homework. The odds aren't very good anyway: the unofficial tracking site CramerProject.com says Cramer's chance of making a wrong call is about 42%. That means that nearly half the time you may be misled.
How about portfolio performance? CramerProject.com says the 30-day average return on the Cramer Index was 14.90% on Nov. 2, though undoubtedly much less on an after-tax basis. The Web site tracks a "Jim Cramer index" of more than 1,600 stocks. You can find data on Cramer's individual stock picks on TheStreet.com, a staggering 3,000 from the prior three months -- about 50 a day. But to get a peek at some of his portfolio data you have to subscribe to his service for $400 a year. Now suppose you're a full-time teacher, cop, attorney or entrepreneur running your own business. You don't have an extra 60 hours a month. Or maybe you're already a nervous active trader whose family wants more quality time, and isn't making that $72,000 breakeven ROI for your valuable time.
So, compare the "lazy portfolios:" They require almost no time, so you can continue making money on your job plus add some nice passive money from your customized lazy portfolio, without wasting the "opportunity cost" on trading. See how the lazy portfolios stacked up in the third quarter.
True, only five of our eight lazy portfolios return more than the 14.9% from "Mad Money's" active trading. But that is giving Cramer a tremendous benefit of the doubt, since the lazy portfolio returns are computed as an annual gain and the "Cramer index" is a 30-day moving average. On Sept. 17, for example, that average was closer to 9%.
Even with that edge, the lazy portfolios stack up well. The Aronson Family Portfolio's one-year return of 23.5% is beating "Mad Money's" number by a wide margin. And the lazy fees, taxes and transaction costs are less than with active trading, if you reflect on the Odean-Barber research.
And even more embarrassing, the passive three-fund "Second Grader's Starter Portfolio" is also beating the CramerProject Index, 19.5% to 14.9%. And that kid's a full-time student, so he doesn't have time to watch "Mad Money." Plus he's doing some real "homework" and it looks like he's already learned a valuable lesson that goes over the heads of the "Mad Money" crowd: "The more you trade the less you earn!" Boo-yah! End of Story
By Paul B. Farrell
This column, originally published Nov. 6, has been updated with a link to Jim Cramer's response.
ARROYO GRANDE, Calif. -- Last week I finally listened to the "Mad Money" show for a full hour. When channel surfing in the past I'd move on after 30 seconds. It's about as educational as Saturday morning cartoons. What I heard was a manic distraction for addicted personalities. But there I was, alone in the car on a five-hour trip back home. So I made a conscious decision to listen to the entire show, first time (and last!). "Oh god, what torture," I screamed aloud somewhere near Gilroy, the garlic capital of the world: "This is crazy-making, what a waste of time!"
Of course that was the voice of passive investors coming out from deep within my soul, speaking for the 90 million American investors who don't have the time to waste watching this inane "entertainment" program that's brainwashing innocent minds, repeating the dot-com drumbeat of the late 1990s. Seriously, most folks have real jobs that take up most of their time, real families, real outside interests, real lives to live.
Fortunately many Americans have figured out that active trading is a dead-end street. Remember University of California-Davis finance Profs. Terry Odean and Brad Barber and their famous study of 66,400 accounts at a major Wall Street brokerage? They concluded that transaction costs, fees and taxes ate much of the pretax returns: "The more you trade the less you earn." Active traders actually made a third less than passive buy-and-holders. And it's still true.
OK, assuming you're one of America's 2 million to 5 million fairly active traders, calm down. I know you're dismissing what I said. But stick with me for a minute. Take a deep breath before you fire off a nasty email. Quash those emotions and let's look at this another way.
Figure your 'opportunity cost' of trading
You already know that the Odean and Barber research tells us that traders are running the race with a huge handicap. So, let's quantify traders' "opportunity cost," the "economic cost of an opportunity foregone" when they spend time playing by "Mad Money" rules (or any other trading game). In short, what's your time worth if you watch "Mad Money" daily and do the "homework" Cramer recommends?
Jim Cramer's a brilliant trader. I interviewed him in the late 1990s when he was a hedge fund manager. He didn't like my criticism of the Mutual Fund Derby Race on TheStreet.com, of which he was one of the founders. Said I was "over the top." That was at a time when a competing dart-throwing chimpanzee's index called Monkeydex was beating America's top funds.
The fact is, what was "over the top" was TheStreet's manic racetrack imagery that encouraged passive investors to start trading funds, only to rue the day a couple years later when the market tanked and lost $8 trillion in a three-year bear/recession. That was bad media. And last week's "Mad Money" program is the same kind of subtle brainwashing that's misleading passive investors unconsciously into high-risk trading.
Work the numbers. Cramer's emphatic: "Do your homework, the right homework." That can mean many things, depending on your approach to stock research. But one thing's certain, Cramer says: "Doing homework could take as much as an hour per week per position."
But when he says that to investors, "they look at me as if I am some kind of old-fashioned teacher who is asking for way too much in this busy world in which we live. That's just plain wrong."
Good advice. But the one hour daily "Mad Money" show is such a manic wisecracking racetrack mentality with funny costumes, bizarre sound effects and boo-yah cheers that it totally undercuts the subtlety of doing passive "homework." It's more like a hard-sell infomercial to get you to buy a trading system "guaranteed to make you a successful trader."
Except "Mad Money" is drawing people into a new 2007 Derby Race, targeting traders with the minds of kids chasing instant gratification. Read Jim Cramer's response.
'Mad Money's' wasted 'opportunity cost' Here's the hard facts folks: How to quantify the economic "opportunity cost" of the "Mad Money" game. Cramer's right, you must do serious analysis of your "positions." OK, so for five hours a week he overwhelms your mind with tons of opportunities. Let's say that somehow, when the smoke clears, you have 10 "positions."
Now let's do the math in this simple economic equation: If you're following Prof. Cramer's rules and doing your "homework" you're watching "Mad Money" five hours a week and doing another 10 hours of "homework" on your "positions." That's potentially 60 hours of your valuable time each month, on top of your full-time job. Assuming you're a professional or business executive, let's say your time's worth $100 per hour, probably more.
So, bottom line: Your economic "opportunity lost" for 60 hours is at least $6,000 a month or $72,000 a year, playing by "Mad Money" rules. Get it folks? Your time is valuable. If you're worth a minimum of $100 an hour and you spend 60 hours a week on any activity, you darn well better be earning at least $72,000 a year. And to make that kind of money at, say, 15% a year you'd need more than $400,000 capital at risk.
My guess is that most of the "Mad Money" audience takes the easy route: They just go emotionally gaga over some of Cramer's manic stock picking and buy some, without doing the necessary hours of "homework."
'Lazy portfolios' outperform 'Mad Money'
The vast majority of American investors, probably 95%, will likely never waste their valuable time playing "Mad Money's" new Racing Derby, watching and doing all the necessary homework. The odds aren't very good anyway: the unofficial tracking site CramerProject.com says Cramer's chance of making a wrong call is about 42%. That means that nearly half the time you may be misled.
How about portfolio performance? CramerProject.com says the 30-day average return on the Cramer Index was 14.90% on Nov. 2, though undoubtedly much less on an after-tax basis. The Web site tracks a "Jim Cramer index" of more than 1,600 stocks. You can find data on Cramer's individual stock picks on TheStreet.com, a staggering 3,000 from the prior three months -- about 50 a day. But to get a peek at some of his portfolio data you have to subscribe to his service for $400 a year. Now suppose you're a full-time teacher, cop, attorney or entrepreneur running your own business. You don't have an extra 60 hours a month. Or maybe you're already a nervous active trader whose family wants more quality time, and isn't making that $72,000 breakeven ROI for your valuable time.
So, compare the "lazy portfolios:" They require almost no time, so you can continue making money on your job plus add some nice passive money from your customized lazy portfolio, without wasting the "opportunity cost" on trading. See how the lazy portfolios stacked up in the third quarter.
True, only five of our eight lazy portfolios return more than the 14.9% from "Mad Money's" active trading. But that is giving Cramer a tremendous benefit of the doubt, since the lazy portfolio returns are computed as an annual gain and the "Cramer index" is a 30-day moving average. On Sept. 17, for example, that average was closer to 9%.
Even with that edge, the lazy portfolios stack up well. The Aronson Family Portfolio's one-year return of 23.5% is beating "Mad Money's" number by a wide margin. And the lazy fees, taxes and transaction costs are less than with active trading, if you reflect on the Odean-Barber research.
And even more embarrassing, the passive three-fund "Second Grader's Starter Portfolio" is also beating the CramerProject Index, 19.5% to 14.9%. And that kid's a full-time student, so he doesn't have time to watch "Mad Money." Plus he's doing some real "homework" and it looks like he's already learned a valuable lesson that goes over the heads of the "Mad Money" crowd: "The more you trade the less you earn!" Boo-yah! End of Story
Buffett's Estate Tax Ear-Bender
More new taxes? That's the surprising mantra of America's second richest man: Warren Buffet. On Wednesday, the billionaire investor and philanthropist urged the Senate Finance Committee to keep the controversial estate tax. Buffett, whose net worth is over $57 billion, has heavily crusaded for more taxes on the rich. While many of his peers may disagree, Buffett staunchly believes that the current tax system favors the elite and overburdens the middle class. Perhaps in a sign of how near-and-dear the tax issue is to Buffett, the head of Berkshire Hathaway addressed the committee without a prepared speech (according to one of his personal assistants). Speaking off the cuff, he said a repeal of the estate tax would unjustly benefit America’s wealthiest.
The estate tax has been a hot-button issue on Capitol Hill this year. Under a 2001 law, the estate tax will be gradually reduced until 2010, when it is suspended for on year. Then in 2011, the tax returns in full force, and estates worth over $1 million could face a 55% tax. While some Republicans have pushed for the tax’s full repeal, many Democrats want the tax to stay in place. It is unclear where Republicans and Democrats will find common ground, but many expect the sides to reach a compromise before 2011.
According to Buffett, the estate tax is important, because it bridges the gap between the poor and rich. “A meaningful estate tax is needed to prevent our democracy from becoming a dynastic plutocracy,'' he said. He said low taxes on the rich (many of the richest Americans are taxed at the lower dividends and capital gains rate) have given them an unfair advantage over the middle class, which fork over a greater percentage of their income to the government.
In a recent interview with Tom Brokaw of NBC, Buffett produced a document that showed he had about $49.6 million in taxable income, 18% of which was paid to the government. For comparison, he said the average federal tax rate for a Berkshire employee was nearly double that–33%.
Proposing a more-direct redistribution of wealth, Buffett said the approximate $24 billion in proceeds from the estate tax, should be redirected to the poor. One way to do it, he argues, would be to give $1,000 tax credit to 23 million low-income households.
Buffett’s focus on U.S. economic disparity may seem like a modern dilemma, but his arguments echo the words of Theordore Roosevelt, the 26th president of the United States. In 1906, the president Roosevelt told Congress: "The man of great wealth owes a peculiar obligation to the state, because he derives special advantage from the mere existence of government,” he said. And the man of great wealth “should assume his full and proper share of the burden of taxation.”
While Buffett’s tax position, seems like an unlikely perch for a man that has aggressively accumulated wealth, he has been a longtime proponent of wealth redistribution. He doesn’t just talk the talk, he also pays up—big. In 2006, Buffett pledged to give 85% of the value in his Berkshire Hathaway stock to charitable organizations. The lion share of that—about $30 billion over 20 years— will go to the Bill and Melinda Gates Foundation. For all of 2006, Buffett gave away $4 billion, or 7% of his wealth.
But Buffett is not a lonely black swan in the Forbes 400 circle. Fellow philanthropist, Bill Gates has said that he is committed to his late father’s pro-tax policy. In addition, George Soros, the chairman of Soros Fund Management, has also lobbied Congress to keep the tax on the books.
The estate tax has been a hot-button issue on Capitol Hill this year. Under a 2001 law, the estate tax will be gradually reduced until 2010, when it is suspended for on year. Then in 2011, the tax returns in full force, and estates worth over $1 million could face a 55% tax. While some Republicans have pushed for the tax’s full repeal, many Democrats want the tax to stay in place. It is unclear where Republicans and Democrats will find common ground, but many expect the sides to reach a compromise before 2011.
According to Buffett, the estate tax is important, because it bridges the gap between the poor and rich. “A meaningful estate tax is needed to prevent our democracy from becoming a dynastic plutocracy,'' he said. He said low taxes on the rich (many of the richest Americans are taxed at the lower dividends and capital gains rate) have given them an unfair advantage over the middle class, which fork over a greater percentage of their income to the government.
In a recent interview with Tom Brokaw of NBC, Buffett produced a document that showed he had about $49.6 million in taxable income, 18% of which was paid to the government. For comparison, he said the average federal tax rate for a Berkshire employee was nearly double that–33%.
Proposing a more-direct redistribution of wealth, Buffett said the approximate $24 billion in proceeds from the estate tax, should be redirected to the poor. One way to do it, he argues, would be to give $1,000 tax credit to 23 million low-income households.
Buffett’s focus on U.S. economic disparity may seem like a modern dilemma, but his arguments echo the words of Theordore Roosevelt, the 26th president of the United States. In 1906, the president Roosevelt told Congress: "The man of great wealth owes a peculiar obligation to the state, because he derives special advantage from the mere existence of government,” he said. And the man of great wealth “should assume his full and proper share of the burden of taxation.”
While Buffett’s tax position, seems like an unlikely perch for a man that has aggressively accumulated wealth, he has been a longtime proponent of wealth redistribution. He doesn’t just talk the talk, he also pays up—big. In 2006, Buffett pledged to give 85% of the value in his Berkshire Hathaway stock to charitable organizations. The lion share of that—about $30 billion over 20 years— will go to the Bill and Melinda Gates Foundation. For all of 2006, Buffett gave away $4 billion, or 7% of his wealth.
But Buffett is not a lonely black swan in the Forbes 400 circle. Fellow philanthropist, Bill Gates has said that he is committed to his late father’s pro-tax policy. In addition, George Soros, the chairman of Soros Fund Management, has also lobbied Congress to keep the tax on the books.
3 Myths About the Turbulent Market
The past few months haven't been short of hair-raising moments in the stock market. From panic to jubilation, and then back to panic, it's hard to tell what's been going on. A credit crunch, a housing crash, a weak dollar, lower interest rates -- it's a lot to take in.
Regardless of whatever problem pops up, there are several investing myths that resurface during turbulent market periods. Here's just a few of them to think about.
Myth No. 1: You can time the market.
Take it easy, Nostradamus. The stock market can be about as twitchy as a shivering Chihuahua. This year alone, we've had several days when the Dow went up or down more than 300 or 400 points in the blink of an eye. Short-term stock movements are determined by buy and sell orders, and people buy and sell for all sorts of reasons -- not all of them rational.
Whether it's a wealthy CEO selling a large block of shares to pay for a new yacht, a hedge-fund manager looking to jump in and out for a quick trade, or a complete novice crossing his or her fingers and hoping for the best, there is no reason to assume you can predict what people will decide to do in the future.
You also have to take into consideration the out-of-the-blue events that make market timing nearly impossible. Suppose you thought Citigroup was due for a quick rebound after it fell from $48 to $42 per share in mid-October. You gather some fancy candlestick charting program that churns out pretty numbers and tells you Citigroup is bound for success. Fantastic! Back up the truck!
Well, not so fast. Before you know it, Citigroup comes out with staggering writedowns and the ouster of its CEO, leaving investors no less than 20% worse off in the matter of a few days. Ouch.
Once in a while you'll get lucky, but don't kid yourself. You can't time the market. Save the fortune-telling for the good folks at the other end of those 1-900 numbers.
Myth No. 2: Fallen stocks must rise again.
What goes down by no means has to come back up. Many of the homebuilding stocks, such a Beazer Homes, D.R. Horton, and Pulte Homes, have taken gut-wrenching hits in the past year, but that doesn't necessarily mean they are cheap. The past several years were a boon to the homebuilding industry, and it could be many, many years before we see construction return to those levels -- if ever.
When you're looking for a cheap stock, it's important not to fixate on how much a stock has fallen from its high. True, bargains are often found in stocks that have taken a beating, but the amount a stock has gone down doesn't dictate whether it's cheap or not. Baidu has gone down some 20% in the past week, yet it still trades at a triple-digit price-to-earnings ratio.
Myth No. 3: Volatility hurts you.
This is one of the biggest myths in all of stock market lore. The majority of investors will be net buyers of stocks over the coming years or decades. Since most of us plan on being investors for the long haul, you should welcome volatility as your friend.
If you're investing in a retirement account that you don't plan to withdraw from for, say, 20 years, but you plan to contribute frequently to it, the best thing in the world that could happen to you is to have a massive stock market crash that lets you purchase investments at bargain prices. Yet many investors panic and head for the hills at the first sign of trouble, even if they know the trouble will be only temporary.
Yes, we're having a credit crunch right now. Sure, housing is ugly at the moment. But does that mean you should dump everything and put your cash under your mattress? Not even close. When the market becomes turbulent, as it has in the past few months, and your favorite companies go on sale, consider yourself lucky. Look past the short-term noise and think about what the goal of successful investing is -- to make money over time.
There are plenty of myths out there. Everyone in the stock market wants to make quick and easy money, but in reality, that's not how the world works. Develop a sound investing plan, stick to your guns, and don't be tempted by greed or fear as the market gyrates to and fro.
Wednesday, November 14, 2007
Our 'Voluntary' Tax Code
The Wall Street Journal, November 14, 2007
By Donald L. Luskin
Should we stop worrying and learn to love the "mother of all tax reform plans" put forward by House Ways and Means Committee Chairman Charles Rangel of New York?
The bill would raise taxes by $3.5 trillion over the coming decade, according to Louisiana Republican Rep. James McCrery, a committee colleague of Mr. Rangel's, making it the largest tax increase in history. There has been so much concern that such a tax increase would hurt financial incentives that drive economic growth that House Speaker Nancy Pelosi distanced herself from Mr. Rangel's plan almost as soon as he announced it.
But fear not. As Mr. Rangel wrote on this page two weeks ago, his bill would "restore a sense of equity and fairness that is critical to the success of our voluntary tax system." That's right, he called our tax system "voluntary." That means we don't have to worry about the incentive effects, since we won't actually have to pay any of that $3.5 trillion -- unless we want to.
So when April 15 comes around, I encourage you to be like Herman Melville's Bartleby and say: "I prefer not to." But wait. By April 15 you'll already have paid, since taxes are involuntarily withheld from your paycheck. Nothing can be done about that, even if you don't volunteer to file a tax return. And if you don't file a return, you'll find yourself involuntarily in jail.
You'll then have to yield to the opinion that Mr. Rangel wasn't being entirely straightforward in writing that our tax system is voluntary. But then, he wasn't being entirely straightforward in writing that his bill, which would further raise taxes on the "rich" who already pay the great majority of federal taxes, has anything to do with equity and fairness.
Perhaps from Mr. Rangel's perspective, our tax system is indeed voluntary. After all, he chooses who pays taxes, how much they pay and how their money gets spent. If he wants to raise our taxes to support a $2 million earmark to create a Charles B. Rangel Center for Public Service at the City College of New York, he can volunteer to do that -- but the rest of us have no such choice.
To be fair, our tax system is indeed voluntary in certain respects. For example, wealthy liberals like Warren Buffett, who call publicly for higher taxes on the rich in the name of fairness, can volunteer to pay more themselves any time they wish to do so. All Mr. Buffett has to do is send a check to Department G -- that's G for "gift" -- at the Bureau of the Public Debt in Parkersburg, W.Va.
Why not try an experiment in which the tax system is made truly voluntary? Already 42 states (as well as the District of Columbia and Puerto Rico) raise revenues with lotteries, through which citizens voluntarily paid $57 billion last year. It's a long and noble tradition. Before the birth of Christ, the Han Dynasty ran lotteries to raise the revenues used to build the Great Wall of China.
Government could be entirely financed by voluntary taxation. Yes, the government would have to be small enough to make do, and citizens would have to be sufficiently public-minded about it. But all 13 original American colonies ran lotteries, and playing them was considered a civic duty. Proceeds from lotteries established Harvard, Yale, Columbia, Dartmouth, Princeton, and William and Mary -- and paid for the cannons that defeated England in the Revolutionary War.
But today, Mr. Rangel might find that the volunteerism in today's tax system is a dangerous thing. His bill would raise the tax rate on capital gains income, but the cap-gains tax is voluntary to the extent that one doesn't have to pay it until one chooses to sell an appreciated asset. That fact is not lost on Mr. Buffett, who believes the rich should pay more taxes, but who has never volunteered to sell even one share of his vast holdings in Berkshire Hathaway -- and thus has never volunteered to pay any cap-gains taxes.
What if every investor did that? It's nice to imagine a nation of long-term investors just like Mr. Buffett. But if stockholders never sold any of their investments, the economy, incomes and job creation would slow to a crawl because a growing economy depends on capital moving freely and continuously to its perceived highest and best use.
Mr. Rangel should also bear in mind that taxes on labor income are voluntary in the sense that one can choose not to pay them by choosing not to earn any labor income -- that is, by not working. All the rich need to do in order to make true Mr. Rangel's characterization of our tax system is to retire to their yachts, rather than continue to contribute to the economy by running hedge funds or doing private equity deals.
When that happens, Mr. Rangel will get a lesson in supply-side economics he'll never forget. Some say that the Laffer Curve is wrong, and that tax cuts don't result in higher tax revenues. But when America's most productive workers stop working -- even a little bit -- in reaction to the incentive effects of the "mother of all tax reform plans," they'll see that the Laffer Curve was right after all, and that it can cut both ways. Involuntary tax hikes result in voluntarily lower tax revenues.
Mr. Luskin is chief investment officer of Trend Macrolytics LLC.
By Donald L. Luskin
Should we stop worrying and learn to love the "mother of all tax reform plans" put forward by House Ways and Means Committee Chairman Charles Rangel of New York?
The bill would raise taxes by $3.5 trillion over the coming decade, according to Louisiana Republican Rep. James McCrery, a committee colleague of Mr. Rangel's, making it the largest tax increase in history. There has been so much concern that such a tax increase would hurt financial incentives that drive economic growth that House Speaker Nancy Pelosi distanced herself from Mr. Rangel's plan almost as soon as he announced it.
But fear not. As Mr. Rangel wrote on this page two weeks ago, his bill would "restore a sense of equity and fairness that is critical to the success of our voluntary tax system." That's right, he called our tax system "voluntary." That means we don't have to worry about the incentive effects, since we won't actually have to pay any of that $3.5 trillion -- unless we want to.
So when April 15 comes around, I encourage you to be like Herman Melville's Bartleby and say: "I prefer not to." But wait. By April 15 you'll already have paid, since taxes are involuntarily withheld from your paycheck. Nothing can be done about that, even if you don't volunteer to file a tax return. And if you don't file a return, you'll find yourself involuntarily in jail.
You'll then have to yield to the opinion that Mr. Rangel wasn't being entirely straightforward in writing that our tax system is voluntary. But then, he wasn't being entirely straightforward in writing that his bill, which would further raise taxes on the "rich" who already pay the great majority of federal taxes, has anything to do with equity and fairness.
Perhaps from Mr. Rangel's perspective, our tax system is indeed voluntary. After all, he chooses who pays taxes, how much they pay and how their money gets spent. If he wants to raise our taxes to support a $2 million earmark to create a Charles B. Rangel Center for Public Service at the City College of New York, he can volunteer to do that -- but the rest of us have no such choice.
To be fair, our tax system is indeed voluntary in certain respects. For example, wealthy liberals like Warren Buffett, who call publicly for higher taxes on the rich in the name of fairness, can volunteer to pay more themselves any time they wish to do so. All Mr. Buffett has to do is send a check to Department G -- that's G for "gift" -- at the Bureau of the Public Debt in Parkersburg, W.Va.
Why not try an experiment in which the tax system is made truly voluntary? Already 42 states (as well as the District of Columbia and Puerto Rico) raise revenues with lotteries, through which citizens voluntarily paid $57 billion last year. It's a long and noble tradition. Before the birth of Christ, the Han Dynasty ran lotteries to raise the revenues used to build the Great Wall of China.
Government could be entirely financed by voluntary taxation. Yes, the government would have to be small enough to make do, and citizens would have to be sufficiently public-minded about it. But all 13 original American colonies ran lotteries, and playing them was considered a civic duty. Proceeds from lotteries established Harvard, Yale, Columbia, Dartmouth, Princeton, and William and Mary -- and paid for the cannons that defeated England in the Revolutionary War.
But today, Mr. Rangel might find that the volunteerism in today's tax system is a dangerous thing. His bill would raise the tax rate on capital gains income, but the cap-gains tax is voluntary to the extent that one doesn't have to pay it until one chooses to sell an appreciated asset. That fact is not lost on Mr. Buffett, who believes the rich should pay more taxes, but who has never volunteered to sell even one share of his vast holdings in Berkshire Hathaway -- and thus has never volunteered to pay any cap-gains taxes.
What if every investor did that? It's nice to imagine a nation of long-term investors just like Mr. Buffett. But if stockholders never sold any of their investments, the economy, incomes and job creation would slow to a crawl because a growing economy depends on capital moving freely and continuously to its perceived highest and best use.
Mr. Rangel should also bear in mind that taxes on labor income are voluntary in the sense that one can choose not to pay them by choosing not to earn any labor income -- that is, by not working. All the rich need to do in order to make true Mr. Rangel's characterization of our tax system is to retire to their yachts, rather than continue to contribute to the economy by running hedge funds or doing private equity deals.
When that happens, Mr. Rangel will get a lesson in supply-side economics he'll never forget. Some say that the Laffer Curve is wrong, and that tax cuts don't result in higher tax revenues. But when America's most productive workers stop working -- even a little bit -- in reaction to the incentive effects of the "mother of all tax reform plans," they'll see that the Laffer Curve was right after all, and that it can cut both ways. Involuntary tax hikes result in voluntarily lower tax revenues.
Mr. Luskin is chief investment officer of Trend Macrolytics LLC.
Wednesday, October 31, 2007
China bubble to burst, Greenspan predicts
Former U.S. Federal Reserve Chairman Alan Greenspan warned Wednesday that there's going to be a "dramatic contraction" in Chinese equities and that the current surge on the Chinese stock market is unsustainable, according to media reports. In recent weeks, a number of financial firms, including Goldman Sachs, as well as Governor Zhou Xiaochuan of the People's Bank of China have expressed concern about the possibility of a bubble forming in the Chinese stock market. The Shanghai Composite Index, which tracks shares listed on the larger of China's two stock exchanges, has gained 56% year-to-date.
Is there anyone who doesn't think the Chinese markets are bubblicious?
The bigger questions are whether or not Chinese policymakers have lost control of the economy.
OK, that was written last May...for anyone owning anything in China they have seen remarkable appreciation.
Yesterday, Buffett continued on as was reported by Bloomberg News:
Former Federal Reserve Chairman Alan Greenspan said China's stock market is a speculative bubble that will burst.Asked if China was in a state of "irrational exuberance," a phrase Greenspan made famous in 1996, he said, "I think so," speaking to a conference of insurance executives in Boston on Tuesday."When you don't expect it, it breaks," Greenspan said of the bubble.
His comments reprise remarks from May, when Greenspan said he was concerned Chinese equities might undergo a "dramatic contraction" after its main stock index at the time had jumped more than 90 percent since the start of the year.Greenspan's latest words of concern come at a time when investors are increasing bets on Chinese equities. Tuesday, PetroChina Co. and Alibaba.com Ltd. sold stock valued at more than $10 billion.
PetroChina, the world's second-largest company by market value, raised $8.9 billion in the biggest stock sale this year.Alibaba, the operator of China's largest trading Web site for companies, sold $1.5 billion of shares in the second-biggest initial public offering of an Internet company, after Google Inc., said two people with knowledge of the matter.China's benchmark CSI 300 index has surged 170 percent this year as the country's households invest more of their $2.3 trillion of savings in equities. The rally has given China more of the world's 10 largest companies than the U.S. for the first time and prompted billionaire investor Warren Buffett to warn that prices have risen too fast.China's stock market value is $3.7 trillion, compared with $18.7 trillion for the U.S."It's easy to be carried away in the stock market when things are going very well," Buffett said Oct. 24. "We at Berkshire never buy stocks when we see prices soaring."Greenspan on Tuesday also predicted a "long-term erosion" of the dollar in part because of the U.S. current-account deficit. The U.S. currency's decline is accelerating, he said.For three years, Greenspan has said the dollar will weaken when international investors tire of financing the U.S. current-account gap, the broadest measure of trade."We are likely to see a long-term erosion of the dollar," said Greenspan, 81, who retired from the central bank in January 2006 after 18 years as chairman and last month published a memoir titled "The Age of Turbulence."
Is there anyone who doesn't think the Chinese markets are bubblicious?
The bigger questions are whether or not Chinese policymakers have lost control of the economy.
OK, that was written last May...for anyone owning anything in China they have seen remarkable appreciation.
Yesterday, Buffett continued on as was reported by Bloomberg News:
Former Federal Reserve Chairman Alan Greenspan said China's stock market is a speculative bubble that will burst.Asked if China was in a state of "irrational exuberance," a phrase Greenspan made famous in 1996, he said, "I think so," speaking to a conference of insurance executives in Boston on Tuesday."When you don't expect it, it breaks," Greenspan said of the bubble.
His comments reprise remarks from May, when Greenspan said he was concerned Chinese equities might undergo a "dramatic contraction" after its main stock index at the time had jumped more than 90 percent since the start of the year.Greenspan's latest words of concern come at a time when investors are increasing bets on Chinese equities. Tuesday, PetroChina Co. and Alibaba.com Ltd. sold stock valued at more than $10 billion.
PetroChina, the world's second-largest company by market value, raised $8.9 billion in the biggest stock sale this year.Alibaba, the operator of China's largest trading Web site for companies, sold $1.5 billion of shares in the second-biggest initial public offering of an Internet company, after Google Inc., said two people with knowledge of the matter.China's benchmark CSI 300 index has surged 170 percent this year as the country's households invest more of their $2.3 trillion of savings in equities. The rally has given China more of the world's 10 largest companies than the U.S. for the first time and prompted billionaire investor Warren Buffett to warn that prices have risen too fast.China's stock market value is $3.7 trillion, compared with $18.7 trillion for the U.S."It's easy to be carried away in the stock market when things are going very well," Buffett said Oct. 24. "We at Berkshire never buy stocks when we see prices soaring."Greenspan on Tuesday also predicted a "long-term erosion" of the dollar in part because of the U.S. current-account deficit. The U.S. currency's decline is accelerating, he said.For three years, Greenspan has said the dollar will weaken when international investors tire of financing the U.S. current-account gap, the broadest measure of trade."We are likely to see a long-term erosion of the dollar," said Greenspan, 81, who retired from the central bank in January 2006 after 18 years as chairman and last month published a memoir titled "The Age of Turbulence."
Monday, October 29, 2007
How a Fed rate cut raises oil prices
Expect even higher crude prices if the central bank cuts interest rates Wednesday.
If you think oil price are high now, wait till Wednesday.That's when the Federal Reserve is set to announce its decision on interest rates. Most say a cut is coming. If the Fed cuts rates, it will probably push oil prices higher.
There are a couple of reasons lower interest rates usually cause higher oil prices. The first is lower interest rates are designed to spur economic growth by making money for investment cheaper to borrow. Stronger economic growth usually entails using more energy, so traders bid up oil prices on the expectation of higher demand.
Second, lower interest rates usually cause the dollar to fall, as they make dollar-denominated investments like Treasurys less attractive for foreign investors.
Oil, like many other commodities, is priced in dollars worldwide. If the dollar falls, oil producing nations, like those in OPEC, need a higher price per barrel to maintain a the same level of revenue. While oil producing countries don't set the price of oil in the market, they do have control over production and are less likely to increase it when faced with the declining dollar. Also, foreign consumers have less incentive to reduce demand if oil is, relatively, getting cheaper for them.
The real question is this: Is a rate cut already priced into the cost of a barrel and, if not, how much higher is crude expected to go?
"Some has been priced in, but we could see more," said Mike Stelmaki, energy analyst. "I think a couple of bucks is possible."
That would push crude prices, already at record nominal levels, to somewhere near $95 a barrel. That's just shy of the all-time inflation adjusted level of between $93 and $101 a barrel (depending on which calculation is used) set in early 1980s during the Iran-Iraq war.
Mike didn't say how much higher oil could go, but also suggested a rate cut hasn't been fully priced in.
"The temptation is to say it must be priced in, but it could still go higher," he said.
He also noted that a deeper rate cut from the Fed, like half a percentage point, would cause prices to jump further.
According to futures listed on the Chicago Board of Trade, investors say there's an 86 percent chance the Fed will cut its federal funds rate by a quarter percentage point to 4.5 percent. The funds rate is an overnight bank lending rate that influences how much interest business pay for capital loans and consumers pay for things like auto, credit card and home equity lines of credit.
Investors say there is a 14 percent chance the Fed will cut rates by half a percentage point, according to futures on CBOT.
The falling dollar is a fairly prominent reason oil prices are moving higher, as "fundamentally, there really haven't been that many things to cause this price rise."
But others say the dollar's role has been exaggerated.
We didn't expect to see much of a price jump if the Fed cuts rates, and attribute oil's recent record run to rising worldwide demand running up against limited supplies.
Thursday, October 25, 2007
Buffett: Expect more subprime pain
Billionaire investor sees problems in the subprime market affecting consumers for up to 2 years, but expresses confidence in U.S. economy.
American billionaire investor Warren Buffett said Thursday that problems in the U.S. subprime mortgage market will likely weigh on consumers for up to two years, but that the U.S. economy will weather the storm.The subprime problem "is having an impact," Buffett said on his first visit to South Korea. "It will have more of an impact."
 |
| Billionaire investor Warren Buffett |
Rising default rates among U.S. mortgage holders with poor credit histories have rattled globalcredit, stock and currency markets since August and raised concerns about a possiblerecessionin the U.S. economy, a major export market for Asian companies.
"In the next 6 months, one year, two years the problems in the mortgage market can cause a lot of problems with consumers and hurt buying power in the United States," he said at a press conference after arriving earlier in the day from China on his private jet.
However, the U.S. economy has often had to face various difficulties and the present was no exception, Buffett said.
"Overall the economy will make progress," he said.
Buffett came to Daegu, located about 180 miles southwest of Seoul, to inspect Iscar Korea, a subsidiary of Iscar, the Israeli industrial tool manufacturer that his company, Berkshire Hathaway Inc., purchased last year for $4 billion, its first overseas acquisition.
Buffett also expressed pessimism on the U.S. dollar.
"We still are negative on the dollar relative to most major currencies," he said.
The dollar has fallen against the euro, British pound, Japanese yen, Indian rupee and many other Asian and European currencies this year. The euro, for example, has gained 8 percent against the dollar this year.
Wednesday, October 24, 2007
Roller Coaster Rides
Roller Coasters take you way up high and then drop down dramatically...up and down and up and down. Then at the end of the ride...you are right back where you started. Hmmmm.
Apparently, no one wants to be short or not long enough headed into another rate cut even amid the bad news out there. After selling off this morning and following a feeble rebound effort, a rumor that the Fed is going to do an emergency rate cut sent the shorts running.
There have been some wild moves over the past week and its been difficult to explain it. Pure manipulation? Perhaps. But no matter what it is, it makes for a difficult time unless you're renting stocks for just a few seconds. We know as we watched the tape reverse course this afternoon. Something strange is going on other than just mere speculation on the Fed's next move. No matter what you think of the economy, the next week or so is going to be an interesting time for the markets and we're not just talking about the continuation of earnings season. Make sure you have your seat belts fastened.
Apparently, no one wants to be short or not long enough headed into another rate cut even amid the bad news out there. After selling off this morning and following a feeble rebound effort, a rumor that the Fed is going to do an emergency rate cut sent the shorts running.
There have been some wild moves over the past week and its been difficult to explain it. Pure manipulation? Perhaps. But no matter what it is, it makes for a difficult time unless you're renting stocks for just a few seconds. We know as we watched the tape reverse course this afternoon. Something strange is going on other than just mere speculation on the Fed's next move. No matter what you think of the economy, the next week or so is going to be an interesting time for the markets and we're not just talking about the continuation of earnings season. Make sure you have your seat belts fastened.
Friday, October 19, 2007
1987 Crash Revisited
Rob Fraim puts out his own amusing comments each day via email. On the 17th anniversary of the 1987 stock market crash, he put out his recollections from that day, and we are republishing them today, the 20th anniversary of Black Monday.
Here is Rob's version of 1987 Crash Revisited. If nothing else please take a look at the charts below.
October 19 – the day that each year gives old-timers in this business a renewed facial tic and post-trauma flashbacks.
“What?” you say. “You mean you were actually there, Grandpa? You remember the Crash of ’87?”
Yes, I was, and yes I do. Confirming rumors that I am, in fact, older than dirt I note that I was in this business in 1987 – and had been for a few years prior (I started in 1983.)
I was having dinner last week with a friend who runs a hedge fund (another graybeard, although he looks younger than me) and we ended up talking about 1987. He had a great story about the whole thing (which I’ll let him tell you about someday if you ever get to have dinner with him.)
So I thought I would take a moment to reflect on my own Crash Experience – and perhaps some of you will share your October 19, 1987 story (provided you’re not a whippersnapper who would be relating what was on freakin’ Sesame Street that day! I really hate you guys. You’re svelte and unwrinkled and smart and energetic and I’m just liable to whup you if you’re not careful.) Maybe we’ll even get a recounting of the aforementioned dinner tale from last week. So if you feel like it, drop me a note with your recollections. If I get enough to make it worthwhile, perhaps I’ll compile them for sharing.)
“What I Did During the War (or What Felt Like One Anway)” or…
“Dr. Strange-Broker or How I Learned to Stop Worrying and Love the Bear” by Rob Fraim
I was 29 years old, 4 years in the business, with two young children. I thought I had investing figured out, didn’t really, and was working for the old Dean Witter (now Morgan Stanley.) The market had been mostly good during my relatively brief time in the business and I had survived the crucial new-guy starvation years and had built up a fairly good book.
So good in fact that I listened to my manager – an advocate it turns out of the “if-you-get-the-brokers-to-really-get-themselves-in-hock-they’ll-be-
forced-to-produce-more-just-to-pay-their-bills” school of thought. (He was also the genius who kept telling us to forget about analyzing stocks ourselves. “Look, we pay those analysts in New York a lot of money to do that. Do you think you know more than those guys? Your job is to sell.” He is no longer in the business, by the way. Last I heard he had left his wife and family and was involved in a relationship with a New Age guru type who had helped him to discover his true “orientation.” He’s raising llamas with this guy and chanting or something. But I digress.”
“You need a new house” he said. “That “piece of#%@ little house of yours isn’t enough. You need to aim higher. Think bigger.” Actually a new house seemed like a pretty good idea, and the kids were getting bigger, and business was good, and hey…what’s a little extra mortgage to a hot-shot like me?
I pasted a picture of a big house on the door of my little office (thanks to the suggestion of my motivational coach in the big office) and embarked on the quest to get me some o’ that.
Before too long I was closing on a house that was twice the size of the old one and came complete with a mortgage that was only 3 times as large. Coolio!
We closed on the house on October 1, 1987.
Oh sure, the market had been a little funky. After peaking in the summer, the market had gone through a pretty good decline – from about 2700 to 2300 or so. In percentage terms, not an insignificant sell-off. But of course it was just: summertime doldrums, a little readjustment, things a little ahead of themselves, no problem, secular bull market, great buying opportunity, hey just look -- now we’re getting a second chance at bargain prices.
And don’t forget: “We’re paying those guys in New York a lot of money.”
On Friday October 16, three of us brokers decided to play hooky and “have meetings scheduled” that afternoon. It was one gorgeous fall day. (By the way, for those of you in other locales – particularly you concrete jungle folks – I heartily recommend my neck of the woods in mid-October. The lower Shenandoah Valley of Virginia – smack in the middle of the Blue Ridge Mountains – is a great place to be when the air turns crisp and the trees put on their autumn show. Drop in sometime. I’ll buy you a beer.)
Making the turn after the 9th hole we stopped in the clubhouse to use the pay phone and call the office (pre-cell phone days you youngsters) and my buddy came back looking a little stunned. “Down 90,” he said. Of course these days 90 points doesn’t mean that much. But down 90 from 2300 was a drop. “It’s over” he went on. “The party’s over.”
The weekend was a little tense, since we knew that Monday would open weak. An understatement as it turned out. The combination of a Treasury Secretary with a big mouth and what was called “portfolio insurance” (which somehow involved the commandeering of the free market system by that crazed computer from “2001 – A Space Odyssey” ) came together in an incredibly imperfect storm.
At some point during the day a strange, battlefield-giddiness sort of took over and we just…all….laughed. It was so surreal that all you could do was just laugh. Mortar shell…giggle…another bomb…chuckle. As the day went on, clients were trying to make moves – a lot of panic selling of course, along with more buying interest than you might imagine. There was one small problem though – the systems just crashed. Market orders, limit orders, stop orders – all in, but no reports.
“Are we filled?”
“Don’t know.”
“Should we re-enter the order?”
“Don’t know – it could have failed and you need to re-enter, or you could be duping a trade.”
“When will we get reports?”
“Any minute now.”
As it turned out it was days later in some cases – and a nonsensical mix of nothing dones, good trades, and fills that were two points or five points away from where you figured they should be. As the day went on and we approached down 500 we were really trying to do some buying. But there was no way to know what, when, if, and at what price trades were filling.
In a strange little wrinkle, I figured out something about the Dean Witter system that day. Back then there was an odd-lot order execution system at Dean Witter. If you put in an order for less than 100 shares close to the limit where it was trading, the system would automatically fill it (internally, not actually on the exchange) and then almost simultaneously fill it on the exchange so that the system was flat on the position. By chance, one of the orders that I put in during the period where executions weren’t being reported was for 70 shares of something or another. Boom. Instant fill. So the next order for 400 shares or whatever it was – went in as 99-99-99-and-3. Boom, boom, boom, boom. I became king of the odd lots for about a day until they wised up and shut the auto-fill system down.
On Monday night, the manager made an evening shift mandatory.
“Call your clients. Tell them what’s going on and what to do.”
“Uhhh….what is going on and what should they do?”
“…..I don’t know. Tell ‘em to buy or sell something.”
His other fabulous idea was to call lots of people that weren’t clients of the firm and act like we had told everybody to get out before the crash and then talk them into transferring their accounts. Oh he was prince of a guy all right. I hope he and Serge and the llamas are happy.
That was October 19, 1987. I went home late and stared at all of my new walls. I had a lot more of them than just a few weeks earlier. And the first (tripled) mortgage payment was due on November the 1st.
In the days after the October 19 crash things did stabilize a bit – even rallying some. Corporations stepped in with real buybacks (not the maybe-someday ones we see so often now.) The Fed flooded the system with liquidity and somebody unplugged the hell-spawned computers. The trading systems got back to working and we commenced to explaining why market orders (and limits, and stops) never filled – and more importantly we had the opportunity in the cooler non-panic moments to actually make recommendations and help people figure out how to proceed. “And of course you bought everything in sight since it was the buying opportunity of a lifetime, right Grandpa Rob?” Well, yeah, we did some good buying to be sure. But hand-over-fist-with-reckless-abandon-because-we-knew-for-sure? Well, I wish we had been that smart. But by the time the systems came back in full function we had rallied a couple of hundred and it was awfully hard to find anyone who wasn’t warning of the Impending Great Other Shoe. So yes, we bought, and bought strong, but not as much as hindsight would dictate.
And what most people forget is that the market made its low, not on October 19, but a couple of months later in December. It’s always simple looking backwards, but tougher at the time (as it was in the 1989 United Airlines-related mini-crash, the Persian Gulf war, the 1994 baby bear, the Long-Term Capital mess, the Russian crisis, post-9/11, etc. Or today for that matter.
At the risk of being called a Pollyanna or a head-in-the-sand type, here’s an interesting little exercise. (And you folks know me, and you know my reasonably cautious market stance at present. I have a long bias and am fairly constructive on the market, but my present “play some defense” mode is well documented. And I’m old and feeble and decrepit, so I’m not a reckless sort anymore.)
But take a look at this chart. Pick out 1987 -- The Great Crash of our generation. And then 1989 (or 1994 or…)
Oh…you needed some dates (and a microscope) to help you find them?
Kind of interesting to look at things from a longer-term perspective sometimes huh?
Anyway kids, that was a day in the life of Young Rob, semi-new broker in 1987.
How about you? Care to share your Crash Day story? (Use the comments below to post . . .)
I’ve gotta run now. Business is pretty good. And I have a meeting with my real estate agent about this house I’ve got my eye on.
The smart guys in New York say it’s all good. And never forget: we pay them a lot of money.
by Rob Fraim
Rob is a broker and consultant with Mid-Atlantic Securities, Inc. -- serving the investment needs of institutions and high-net worth individual clients nationwide. A 21-year veteran in the investment industry, he lives and works in Roanoke, VA.
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