Opinion

The Great Debate

Dubai not a canary but another miner needing oxygen

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.
DUBAI WORLD MEETS MORAL HAZARD WORLD
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.)

Dubai must recover investor faith

BRITAIN/– Neil Unmack is a Reuters columnist. The opinions expressed are his own —

Some kind of debt restructuring was inevitable for Dubai’s myriad overleveraged borrowers, but the emirate’s decision not to support property developer Nakheel and seek a debt standstill for holding company Dubai World has devastated its standing in financial markets. Dubai’s future and ability to attract much-needed external capital will depend on how it handles the fallout.

It is rare to see a company announce plans to launch a bond on the same day it threatens creditors to one of its main businesses with potential default. That’s what Dubai just did, when it asked creditors of flagship holding company Dubai World and property developer Nakheel, owned by Dubai World, for a debt standstill until next May on the same day it announced plans to sell a bond for its electricity and water authority.

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