The Lehman Bros. of the Persian Gulf
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The Lehman Bros. of the Persian Gulf
By Daniel Gross
Posted Monday, November 30, 2009 - 3:48pm
Dubai was supposed to be a new model for economic development in the Persian Gulf, and in the world. And like so many recent "new models," Dubai is proving to be a lemon.
The theory was that Dubai would be a competitive, free oasis in a region generally hostile to the open market. Lacking oil resources of its own, it set itself up as a sponge to sop up resources-generated cash. Dubai would be the playground, shopping mall, financial center, cultural zone, beach resort, and second-home mecca of the global oil patch—New York, Las Vegas, and Miami wrapped up in one. In a part of the world where politics were generally poisonous, Dubai was a comparatively free space, open to all investors. The world's financial elite embraced Dubai's new image as a blue-chip. In this year's World Economic Forum's ranking of the most competitive economies, Dubai came in 23rd, up from 31st the year before. It was the highest-ranking country not in Europe, developed Asia, or North America. Conservatives embraced Dubai as a small-government, capitalist heaven. "Think Dubai. Free and rich," as Donna Wiesner Keene wrote in a letter to the New York Times.
Of course, Dubai was never particularly free. Now it's not quite so rich. And, shorn of access to easy money and weighed down by enormous amounts of debt, it's becoming less competitive. Like so many other blue-chips that garnered headlines during the boom years, it was held aloft by loans and a global bubble heavily concentrated in commercial real estate. Now that it has stopped paying debts owned by government-controlled companies, Dubai looks less like Singapore and more like an institution whose epic fail in 2008 helped paralyze the global financial system: Lehman Bros.
Like Lehman, Dubai made the mistake of borrowing short-term to buy long-term illiquid assets. The holding companies Dubai World and Nakheel borrowed tens of billions of dollars from global capital markets and used the funds to buy stakes in Cirque du Soleil and Barney's, yacht businesses, financial-services companies, and, above all, real estate. In much the same way, Lehman plowed its hundreds of billions of borrowings into illiquid investments such as commercial office buildings and apartment complexes. (When it went bust, Lehman had more than $40 billion in commercial real estate on its books.)
Lehman exploited all the new tools of financial engineering—the commercial paper market, CDOs, etc. Dubai did the same with all the new tools of civil engineering: a palm-tree-shaped complex of islands, an indoor ski resort, the tallest building in the world.
In theory, Lehman was a model of modern corporate governance. Public shareholders were represented by an august board, which was supposed to supervise an experienced leader. In practice, it was an autocratic regime run largely for the benefit of insiders and disdainful of outside stakeholders. The same holds for Dubai, where the key companies are essentially arms of the state and are controlled by the royal family and its associates. When challenged about emerging financial problems, Lehman Bros. leader Dick Fuld adopted a tough-guy approach. "I will hurt the shorts, and that is my goal," he said in the summer of 2008. When questions arose about Dubai's financial management, its leader, Sheik Mohammed bin Rashid Al Maktoum lashed out: "So to the people of you who nag over Dubai and Abu Dhabi, shut up!" Ultimately, neither leader was worthy of the praise and presumption of competence that the markets had given them.
Emirates Twin Towers by KARIM SAHIB/AFP/Getty Images
Comments
Dubai should not reward moral hazard- Much ado about nothing !
For a sane analysis of what is going on with Dubai and global finance, see, from the ex-EBRD chief economist:
http://blogs.ft.com/maverecon/2009/11/the-intrinsic-unimportance-of-dubai-world-and-the-important-wider-message-it-conveys/
Global markets, lead by Asia, already have recovered from Dubai fears, indicating what the saga is all about: media hype, and fear of reckoning by those very same greedy banks and funds who got rich off of TARP in the US. But Dubai (or others) have no reason to reward moral hazard.There just is too much doom and gloom about Dubai or MidEast finances in general. Just think- the Emirates alone have more than a trillion $ in reserves. Then compare it with the US debt load of about 120% of GDP, or about $17 trillion ! (this ratio is estimated from 80% to several hundred percent, depending upon OTC obligations accounting, showing how transparent itself the US economy is.) This is a repeat from last year when Western journalists had left Dubai for dead. Well, its demise was great exaggerated, to cite Mark Twain. It's deja vu all over again. What such visionary pundits also have ignored is the smart rebound of Asian economies, these being increasingly decoupled from Western economies, despite major loss of exports to US/Europe. Surely there is a lot of pain, but with US unemployment at a real 17.5%, and both Europe/US talking of a double dip, Dubai hasn't fared that poorly. Over last year 400,000 additional folks came to the UAE, as opposed to the flight notions of hundreds of thousands leaving Dubai for good. Yes real estate will be bad for some years to come (where is it doing really well, anyway?), but there is good infrastructure spending. This bond issue will be resolved in the usual way- some bondholders, especially the impatient fly-by-night ones (e.g. those morally upright New York hedge funds and UK banks) will take haircuts (losses), the portfolio will be restructured and business will resume, with additional liquidity pouring in. Dubai will be doing a wise thing to conserve its recent fundraising for local infrastructure spending and local jobs. Remember that emerging bonds have been the only consistent and highly profitable investments in this climate (100-200% annual returns.) It is thus going to be a smart move to invest in the restructured Dubai bonds to extend this emerging bond run in your portfolios. By the time China and Eastern Europe too face similar real estate situations next year, Dubai will already be on the road to major investments recovery. Given governance issues we will see a change of guard with top officials and much better regulation. Fundamentals matter. A growing youth demographic that is increasingly educated, oil receipts, small local populations and a 5-7x expat population that is a flexible cushion, with ample reserves, there really is no such thing as a long term fiscal crisis anywhere in the Gulf economies. Try justifying the same for Western economies for the next 20 years.These short term episodes are reminders to be prudent, and big capital gains for those new investors.