Dubai not a canary but another miner needing oxygen

December 1, 2009

cr_lrg_108_jamessaft1.jpg– James Saft is a Reuters columnist. The opinions expressed are his own –
Taken all in all, Dubai’s debt crisis is the most significant financial development of 2007. Here in late 2009 it amounts to far less.
Back in the day it would have been a newsflash that apartments ultimately require occupants, that investment needs to be ratified by cash flows, and that debt, Sharia-compliant or garden variety, someday must be repaid.
Dubai’s difficulties are being sold as the commercial real estate debacle somehow morphing into a sovereign debt crisis and it is true that the effective borrowing rates of the more raddled national borrowers such as Ireland have been driven up in recent days.
Dubai’s government said on Monday that it is not responsible for the borrowings of Dubai World, a state-controlled development conglomerate saddled with huge debts amid a property market where the going rate has halved.
Dubai last week applied for, or imposed depending on your point of view, a six-month repayment freeze for Dubai World and its property developer Nakheel.
“Creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct,” said Abdulrahman Saleh, director general of Dubai’s department of finance.
Quite, and hopes that credit extended to Dubai World would be made good by the state of Dubai or by the richer emirate of Abu Dhabi seem to be foundering. This is bad news for those creditors, with the worst potential losses traceable to banks in Britain and Europe, but its probably just not that big of a deal.
For one thing, the amount potentially at issue, even if you allow for an extra 50 percent off balance sheet taking it to circa $125 billion, is simply not big enough in the scale of things to tip significant players over the edge.
And it tells us very little about the state of the world or the likely outlook for real estate. It is very hard to call something a canary in the coal mine when you are already cleaning up after a mining disaster.
For a time the magical thinking behind Dubai, “build it and they will come”, worked and despite it being remote, having an inhospitable climate and little inherent commercial reason for existing, the city boomed. It’s a bit like having a feast so the harvest will be good rather than when it actually is, but it was effective for a time as prices rose and investment was attracted.
The nub of the meme in financial markets is that this is about sovereign exposure and that creditors will be shocked if the state support they thought they had coming never arises.
But is it terribly bad news for the rest of us? Probably not. Investors should have seen it coming – there have been quite a few headlines recently about the real estate crash-  and should not have conflated “implicit” with “explicit”.
Dubai has made clear in its own bond prospectuses that it might lend support but that it was under no obligation to do so. Teaching investors the difference between “quasi-state” and “state” is a good thing.
So why then did the cost of borrowing for Greece and Ireland, as expressed in insurance contracts against default, go up?
Nothing about Dubai’s predicament will have much of an impact on Irish or Greek tax revenues clearly, and the banks and the pool of lendable capital has not been diminished by much.
Nor is it easy to draw a new connection between Dubai and the emerging European countries which represent a muchmore substantial and potentially grave threat to banks in Europe.
Perhaps this is ultimately about moral hazard – risk taking under the belief that you are “insured” –  as are all stories involving the words “quasi,” “government,” and “debt.”
Fannie Mae and Freddie Mac’s quasi-government status fed moral-hazard driven risk taking, as did Dubai World’s, as is most certainly the case where government insurance allows for cheap borrowing.
Markets went down on Dubai because they have become addicted to moral hazard and anything that doesn’t conform with the idea that all shall be bailed out is scary.
It is apparently terrifying that a government should say “hard luck” to anyone anywhere, no matter how difficult the government’s situation is or how ill-founded the investors claim to relief.
None of this is to say that the commercial real estate crash isn’t terrifying, or that countries like Ireland and Greece don’t face difficult times and huge risks, but only that Dubai tells us little new about those things.
There is definitely a moral hazard trade out there, but Dubai is not the event which will cause it to unwind.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.)


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It’s time to rewrite corporate finance textbooks to take away the term “risk free rate” in CAPM formula.There is no such thing as risk free asset anymore. The minute the investor sinks money into an investment, he better prepares to kiss the money goodbye.

Posted by scheng1 | Report as abusive

Western commentators, especially conservatives, claim Islamic countries have communist or socialist leanings. Islam and communism goes hand in hand they say. But here you have a Dubai official saying “creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct.” Keep in mind that the U.S. bailout originated from the Bush administration.

Posted by Gary | Report as abusive

I don’t think we should pin any tag on Dubai World or tried to figure out what they were thinking. I would suspect they got caught up in their own egos and the creditors got caught up in some quick easy money scheme. I do think that the investors lacked due dilligence in their assessment of the risk and I also believe that the investors missed one basic fact. That fact is that the owners were looking for big profits on resale and they were in dreamland as far as planning was concerned. Just as any home builder knows you don’t start another house until the one you finished is sold. Those construction loans are hell on the pocketbook.

Posted by f belz | Report as abusive

Call Dubai the land of ‘moral hazard,’ call it loose business scruples. I call it Dubai, the land of make believe. Dreams did indeed come true. Now, it’s wake up time.Even today, Sheik Mohammad still lives in a land of make-believe. One where the rest of the world has been mislead by the newsmedia. He and his hareem of silk-suited yes men continue to pretend there is no problem in Fantasyland…all you have to do is make believe some more, out about seven years should do the trick.

Posted by JMFulton, Jr. | Report as abusive

I wouldn’t call it a moral hazard .Real estate in Dubai is a high-end luxury market, which logically suffers under conditions of global economic crisis. And markets in Dubai didn`t go down due to their “addiction to moral hazard” , they collapsed due to lost investments, of firms pulling out their money , because of econ.crisis.

Posted by Suzy | Report as abusive

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Posted by The Great Debate » Debate Archive » Dubai not a canary but another … | Dubai for Visitors | Report as abusive

James, thank you for your informative opinion. I tend to agree with JMFulton, Jr.’s comment to some extent and perhaps my following brief words shall confirm that fact.

Dubai is nothing more than an unusually large mirage shimmering in the heat of greed and financial
desperadoes. Its Babylonian structure is based upon delusions and it will fade away.

Posted by Kadaitcha_Man | Report as abusive