Posted by: mostwanted | Thursday, December 3, 2009

Vegas of the Middle East (without the casinos or the booze or the women)

Subprime Dubai – Are the Good Times over?

While we in the US spent our Thursday eating turkey and watching football, the rest of the world’s markets went into a downward spiral as Dubai announced it wanted its lenders to give the country a six-month moratorium on some $60 billion in debt repayments (what happens to interest accumulation at this point?). This has the potential to be the largest sovereign debt default since Argentina as speculators state real debt owed maybe closer to $80-90 billion and this hidden/off the book debt is the most disturbing news to upset the world markets over the last few trading sessions apparently. Somehow this was a shocking development. (Duh how can too much debt and real estate be a problem?) And by markets I mean gold, commodities, oil, stocks, and risk assets everywhere. They all went down. The US markets experienced their own sell-off on Friday, though not as deeply as the rest of the world.

Just to clarify a bit further – while the enterprise in trouble, the Dubai World [DW] corporation (who made a bid for US ports security a couple years back), is a subsidiary of the Dubai government, it is for all intents and purposes its own business unit. The Dubai government said on Monday it wasn’t responsible for the debts of Dubai World, dealing a blow to creditors’ assumptions that the Arab emirate would guarantee the conglomerate’s liabilities. “Creditors need to take part of the responsibility for their decision to lend to the companies,” said Abdulrahman al-Saleh, director general of Dubai’s Department of Finance. “They think Dubai World is part of the government, which is not correct.”

To get an answer, let’s look at some facts about Dubai. It’s one of the Arab Emirates (city-states), but unlike its neighbor Abu Dhabi, oil is only about 6% of the local economy. While the foundations of this city (and the rest of the country for that matter) were built on oil revenues, the city has diversified into finance, real estate, tourism, trading, and manufacturing. It’s a small emirate, with a little under 1.5 million residents, but with less than 20% being actual citizens of the UAE– the rest are expatriates (foreigners who can never become naturalized citizens according to UAE law). The city’s GDP is estimated to be around $50 billion. In comparion, the GDP of my city – Austin, TX is some $72 billion. And with much bigger $700 billion bailouts given to companies in trouble last year by the US government, one would think such relatively small debt of DW would be peanuts. Au contraire mon frere – the problem here seems to be the chance or rather the risk of Dubai defaulting on its debt not just equivalent to its entire GDP but possibly double that.

Dubai has become a byword for thinking large. The world’s tallest building, underwater hotels, the largest man-made islands (plural), indoor snow skiing in the desert… the list goes on and on. Then came the credit crunch. Property values dropped by as much as 50%. Sales, say the developers, have slowed. Now theres an understatement if I ever heard one. Seems there was a lot of debt used to speculate on real estate by DW, not to mention buying assets such as Barney’s, Las Vegas casinos, banks, etc. So who’s on the hook for all the capital for these ambitious projects and purchases? Looks like 50% of the debt is held by UK based banks with the lion’s share of the other half being held by other euro-zone members. US banks seem to have little exposure. Admittedly, the estimates may be confusing the debts of Dubai with that of its neighbor and capital Abu Dhabi, so it’s hard to know a reliable number, other than that European banks are the most exposed.

Now, here’s the deal: Abu Dhabi has the world’s largest sovereign wealth fund at over $650 billion. Dubai has a “mere” $15 billion. If they cared to, Abu Dhabi could write a small check and make all the problems disappear. It just seems that they’re not ready to do that — at least not yet. Apparently, Abu Dhabi already got (owns) the world’s tallest building on past debt problems which was built and is located in Dubai.

Construction and real estate were as much as 25% of Dubai’s economy. Let’s see — large leverage with maybe $5 billion in interest in a $50 billion economy that’s 25% construction? A construction and real estate-driven economy. A real estate bubble. Sounds like CA, FL, Spain, LAS VEGAS, anyone? How can this be a surprise, except that everyone expected big brother Abu Dhabi to pick up the check?

While Abu Dhabi did advance $5 billion earlier, Dubai isn’t letting that money out of the country just yet. There are live projects to be finished (on-time), you can understand. From where we sit, this is just a rather hard-headed negotiation; a restructuring of who owns what and who will get what assets. It will all settle down (eventually). Given the massive losses that world banks have already taken, this is rather small chump change.

But in any event, one of the lessons to be learned is that investors should pay attention to where the leverage is. Unsustainable debt trends end in tears — always do. Spain, Greece, Italy, the UK, and Japan will all have to face major restructuring in the next decade due to major leveraging. And we in the US will also find that we cannot grow debt at our current (unsustainable) levels. Will we pay our debts willingly or be forced to by the markets? Either way, it will make for a less-than-optimal economy over the coming years.

P.S. In the title, casinos should be in quotes because while there are no legal slot machines or poker tables in gambling dens (AFAIK) in all of the UAE, there is definitely gambling going on in the country – albeit with someone elses money on a much larger scale.

In the same breadth, booze also, according to some of my non-muslim friends, flows freely (if you know where to look) as if you were in the south of France. And while there may not be any strip clubs or such, Dubai is notoriously famous for its Euro-trash “street workers”.

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