Saturday, November 28, 2009 0 comments ++[ CLICK TO COMMENT ]++

Thoughts on the Dubai default situation

Writing, I'm sure on a dreary March 6th of 2008, with at least one spelling mistake I now notice, I wondered if Dubai, what I termed the city of fortune, was an illusion.

Well, now we know the answer. A lot of it was indeed an illusion. However, the unfolding events appear to be a shock to the investment community. It shouldn't be.

The most overrated story out there is the Dubai situation. The default has been blown out of proportion given the economic impact. The amount involved, if we ignore any potnetial derivatives, off-exchange contracts, and other dubious bets, appears to be very small. Some analyst peg total exposure well under $100 billion. There are some implications but they have little to do with economics and more to do with politics.

If I'm not mistaken, this is the first sovereign default since Argentina so some are shocked. However, sceptics like me have warned about a potential emerging markets bond bubble. I have less confidence in this call (since emerging markets did improve their credit worthiness e.g. Brazil) but it made no sense to me back then, and it still does not, how emerging market bond spreads were so low (refer to the 2nd part of this post to get an idea of how low EM bond spreads fell relative to US Treasuries (note that the chart only goes up to end of 2007 so the situation has changed a bit since then.) Historically, EM bonds were very risky yet investors started treating them as low-risk bonds. Dubai is not an emerging market (I think it is counted as developed) but it resembles an emerging market.

Besides, what did the lenders expect when you build more real estate than is required by the entire population of Dubai and some of its surrounding countries? Build it and they will come? At least other potential bubble regions, like China, have population to back up the need (however, do note that the vast majority of Chinese can't afford the buildings unless you assume real estate always goes up i.e. guaranteed capital gains.)

So the negative economic impact will be minor. In fact, as I had suggested in the past, these buildings will stand for decades or centuries so there may still be some use out of them.

The real negative impact of the Dubai situation is largely political. It's probably not surprising that the business media glosses over this because, well, they only care about money.

The unfortunate thing about the Dubai default is not the losses; rather, it is the fact that UAE will seize control of Dubai. I'm not a fan of Mohammed bin Rashid Al Maktoum, the leader of Dubai, but by Middle Eastern standards, he is very liberal. In a region of extreme religious conservatism, Mohammed bin Rashid Al Maktoum was able to develop a multi-ethnic city with (largely) open travel, bars, nightclubs, hotels, and so forth. So, Mohammed bin Rashid Al Maktoum's planning skills and exuberence may resemble Donald Trump, but at least he had, what I view as, very positive and significant, social impact. Unfortunately, the default is going to roll back all of that.

Once the leadership in UAE takes control, I wonder how Dubai is going to end up. So, maybe I was mistaken; I said this is the final chapter of Dubai (at least for the next decade) and I may never write about it again, but perhaps not. It seems there is still one final chapter left—that being the outcome after UAE takes over.


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