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.
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