Dubai or Nothing?

There are a pile of debtor nations; the United States is at the top of that list with over $12 trillion (adding a lovely average of $3.81 billion a day since September of 2007 – just short of $40K per citizen), but at least the debt is payable in U.S. dollars. For lots of the rest of the world, most of the debtor nations can tread water as long as interest rates stay really low. But, er, we know that sooner or later, interest rates have to soar or no one will be covering all this debt.

You can get a pretty good view of the risks involved by looking that those lovely credit default swaps or simply at the direct cost (to a bond holder) of insuring a nation’s debt obligations. For example, folks are terrified of Lithuania and Greece, staggering under unmanageable debt loads, and in the past week, these insurance costs jumped up 6% for Lithuania and a whopping 16% for Greece. Spain and Holland are not too far behind.

But who would’ve thunk that that little financial center in the oil rich Middle East, Dubai, would be completely unable to meet its debt service obligations. You know, the place with the mega-tall super-buildings and those incredible, palm-leaf-shaped artificial islands. Apparently, in this real estate meltdown, there really aren’t enough people to rent or buy the underlying space or even occupy the glitzy hotels at the required rates. So the this little Emirate’s investment arm, Dubai World, that built most of this stuff, has asked its lenders to accept a six month moratorium on interest payments. It’s like asking your mortgage lender to let you stop paying interest for half a year… except you might be more likely to resume payment than Dubai World, which is still very unlikely to find people to rent their massively over-built residences, hotels and office towers even in six months.

Dubai has built its fortunes on being the progressive regional financial center (with a tourist twist), since this Emirate has not been blessed with the oil reserves of its neighboring Emirates, like Abu Dhabi. And while oil rich Abu Dhabi may in fact bail out its profligate neighbor, they are more likely willing to let Dubai World twist in the wind for a while, a painful reminder of frothy excess. Just as economists are patting themselves on the back for declaring this recession over, perhaps they are about to eat their words, if in fact this “canary in the coal mine” is a harbinger of things to come.

The November 27^th New York Times: “In a worst-case contagion, Bank of America analysts wrote Friday, ‘One cannot rule out — as a tail-risk — a case where this would escalate into a major sovereign [read: governments of heavily indebted nations] default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s.’… And not just emerging markets. ‘Dubai shows us that what we are now facing is a solvency issue, not a liquidity issue,’ said Jonathan Tepper, a partner at Variant Perception, a research house in London that has been outspoken on the debt problems facing European economies.”

Yeah, well, liquidity means you have the values, you just don’t have the cash. Solvency challenges both whether you have the cash and if the values are really there. We’re only looking at $59 billion of debt in Dubai World, only about .04% of the world’s cross border obligations, not much by global standards. “Still, one concern is that some British banks with large credit exposure to the United Arab Emirates are already troubled. Royal Bank of Scotland, majority-controlled by the British government, was one of the largest lenders to Dubai World, having secured $2.3 billion worth of loans to it since early 2007, according to a report by J.P. Morgan. Standard Chartered and Barclays were also large lenders to the region, with more than $10 billion between them, analysts said. HSBC has $17 billion exposure to the United Arab Emirates.” The Times.

But the global stock markets, even the Dow, plunged at the news. I suspect it was not over the relatively minimal exposure from the potential Dubai default. “The Dow Jones industrial average fell 154.48 points, to 10,309.92 Friday, as markets in Europe and Asia closed slightly higher after opening sharply down for the third consecutive day. Crude oil prices fell to a six-week low; gold fell as investors sought havens.” The Times. So for all those folks who are telling us the worst is over, there may be some serious explaining to do.

I’m Peter Dekom, and I think someone is missing the obvious.