We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.

The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.

These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.

When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?

Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.

Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.

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Friday, June 27, 2008

Biotech Could Go After Pharmaceutical Companies As it Gears Up for Mass Market Diseases

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Leave it to conventional wisdom and pharmaceutical companies would continue to buy biotech companies as they search for much needed growth. But as biotechnology companies go after more mass market diseases would they in-turn buy their pharmaceutical brethren?

While nobody is saying it will happen tomorrow, analysts said biotech companies, usually the prey, could eventually become the predator.

“Pharmaceutical companies are becoming like biotech companies and biotech companies are becoming like pharmaceutical companies,” said Geoff Porges, a biotech analyst at Sanford Bernstein. “It’s much harder to distinguish what a biotech and pharmaceutical company is.”

Rewind a couple of decades and there was a clear distinction between biotech and pharmaceutical companies. Biotechs, back then, were considered unproven companies that were going after niche diseases and that didn’t have the potential to churn out a blockbuster drug. Meanwhile pharmaceutical companies were the ones developing the drugs for the big diseases like high cholesterol and arthritis. The success of companies like Amgen (AMGN) and Genentech (DNA), however, demonstrated the importance of biotech discoveries.

Because biotech companies focus on niche drugs, they typically have smaller sales forces and marketing might. While growth has been strong for the industry, there are signs biotech companies could be setting their sights on more mass market diseases. With a push into mass market drugs comes the need for legions of sales people to knock on doctors’ doors and sell the drugs. Unlike drugs for niche diseases that basically sell themselves, there’s a lot of competition for mass market disease drugs. That, said analysts, could prompt partnerships or M&A.

“The question is do they need the support of large pharma or not,” said Shiv Kapoor, a biotech analyst who has worked for Citigroup, Montgomery & Co. and Ferris, Baker, Watts. Companies like Amgen that are large enough can do it on their own, but may benefit from partnering or buying a company to do the selling.

According to Kapoor, Amgen is expected to report phase III trial results for denosumab, its osteoporosis drug, in the third quarter, and the chances are high the drug will get approval if trial results are positive. Amgen, he noted, hasn’t said if it will partner to go after the larger osteoporosis market. Mary Klem, a spokeswoman at Amgen said the company hasn’t announced its marketing strategy for denosumab as its still focused on getting through clinical trials.

According to Porges of Sanford Bernstein, Genentech said at a recent analyst meeting it was interested in neurological diseases, which he said could include mass market diseases. A spokeswoman at Genentech said the company is not focused on neurological drugs for the masses but areas where there are unmet medical needs like in Alhemizers. Genentech is not “getting into me-too drugs,” said the spokeswoman.

“Gilead’s got a pipeline drug for hypertension and I doubt they will market it themselves,” added Kapoor. They will either do M&A or partnership “depending on the deal and deal terms.” A Gilead Sciences (GILD) spokesman said the company is currently focused on trials for its resistant hypertension drug called darusentan. The company declined to comment on whether it has a strategy focused on mass market diseases.

In the case of mid-sized biotech companies like ImClone (IMCL), Onyx Pharmaceuticals (ONXX) and Myriad Genetics (MYGN), biotech analyst Kapoor said they don’t have the resources to create large sales forces, which makes the question of partnering or deal making more pronounced if they are targeting mass markets.

“Pharmaceutical companies have a major asset that biotechs don’t have, which is expertise in sales and marketing,” said Sanford’s Porges. “How valuable is that versus the R&D engine and/or new technology is the question.”

While M&A could happen, the current valuation of large biotech stocks may act as a road block, at least in the near term. Some industry watchers argue that biotech companies won’t need to go after mass market diseases for years because there’s enough growth with their existing drugs that can be used for other indications.

“The valuation of large biotech stocks are at historical lows,” said Kapoor. “If I was managing a large biotech I wouldn’t try to buy companies because I don’t have the stock cache.”