November 28, 2009
Of the many countries that gorged on debt in the boom years, Dubai stood out. In the space of a few years the emirate’s investment arm, Dubai World, racked up $59 billion in debt, borrowing to build lavish developments like a giant island shaped like a palm tree to entice celebrities like Brad Pitt, and to invest in glittery properties like the MGM Grand Casino in Las Vegas.
Now that the boom has gone bust, both in Dubai and in the United States, Dubai is stuck with a glut of real estate that no one wants to buy or rent. Creditors and markets had always assumed that when push came to shove, its oil-rich neighbor Abu Dhabi would bail out Dubai. But that assumption was called into question this week, and the resulting fear that Dubai might not be able to pay its bills sent a wave of uncertainty rippling through markets just as investors thought the worst of the global financial instability was over.
The anxiety reached Wall Street on Friday, sending the Dow Jones industrial average down more than 150 points, as investors worried about hidden debt bombs in other countries and institutions — heavily indebted nations like Greece and even Britain, high-flying emerging markets and even European and American banks that had lent Dubai money.
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 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.
On Wednesday, Dubai requested that Dubai World be allowed to skip six months of interest payments on its debt. Before then, Dubai World, the corporate face of the emirate, had commissioned the city state’s flashiest buildings, managed ports around the world and reached far overseas to invest in properties like Barneys in New York.
Now, just as Bear Stearns was a harbinger of a string of failures of overly leveraged investment banks, the concern is that Dubai could be the canary in the coal mine for heavily indebted countries. The debts of everyone, including Japan and the United States, not to mention emerging markets, have risen greatly as the countries have fought the ravages of the global recession.
“Whether you are Dubai, Greece, Spain, Ireland or the U.K., you can print as much money as you want, but at the end of the day you have to pay the interest on your debt,” Mr. Tepper said.
Dubai is one of the few member states of the United Arab Emirates that has little oil wealth of its own. It acts as the trading, tourist and financial hub of the emirates. But it was assumed that the U.A.E.’s richest oil state, Abu Dhabi, would always bail out its free-spending neighbor.
Dubai’s announcement on Wednesday reversed that presumption — even as investors fretted that Dubai risked a sovereign default that would ripple to developing nations.
And while Abu Dhabi may well want to make its more exuberant neighbor and its bankers suffer a bit for their profligate ways before it rides to the rescue, that gives little comfort to investors already wary of the region’s growing debt.
“This came as a big shock,” said Fahd Iqbal, an analyst at EFG-Hermes, an investment bank focused on the Middle East. Although Mr. Iqbal said he held to the view that Dubai in the end would avoid default, he acknowledged that the measure had severely rattled confidence in Dubai. “One of the main issues now is of credibility and the potential impact on future fund-raising, which could have knock-on effects on building and infrastructure plans for Dubai and the United Arab Emirates,” he said.
By the numbers, a tremor in Dubai should not necessarily shake the world banking community. According to data from the Bank for International Settlements, foreign banks have $130 billion of exposure to the United Arab Emirates, with Britain having the largest exposure, $51 billion. Banks in the United States have debts of $13 billion.
That is a negligible 0.4 percent of foreign banks’ total cross-border exposure, said Stephen Jen, an analyst at the hedge fund Blue Gold capital management.
In fact, Dubai World’s largest creditors are domestic banks in Dubai and Abu Dhabi.
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.
But while a Dubai default may not provoke a banking crisis, it could well spur a broader crisis of investor confidence in overly leveraged economies.
World markets did not take long to reflect this insecurity.
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 cost of insuring the debt of economies like Greece and Lithuania spiked 16 percent and 6 percent, respectively, this week. The cost of insuring Dubai’s debt shot up by 67 percent and the British pound weakened against the dollar for the week.
Greece and Britain have historically high budget deficits that exceed 12 percent of gross domestic product, with Spain not far behind and Ireland struggling with the consequences of a devastating real estate collapse.
While no one is expecting an outright default as long as global interest rates remain low — largely due to aggressive government bond purchases by central banks — concerns have been building for months that once these easing measures end, interest rates will spike and investors will become less willing to trust the word of heavily indebted governments.
For now, most of the pain from Dubai is being felt by the holders of the Islamic bonds of Nakheel, the developer owned by Dubai World that is known for the palm-themed islands it built.
On Dec. 14, $3.52 billion in Nakheel bonds come due. One of the largest Islamic group of bonds issued, the deal was snapped up by Western and regional investors. In a reflection of how sure investors were that Dubai would meet these payments, the bonds were trading at a 10 percent premium to face value earlier this week. They are now trading at around half of face value.
Of the many countries that gorged on debt in the boom years, Dubai stood out. In the space of a few years the emirate’s investment arm, Dubai World, racked up $59 billion in debt, borrowing to build lavish developments like a giant island shaped like a palm tree to entice celebrities like Brad Pitt, and to invest in glittery properties like the MGM Grand Casino in Las Vegas.
Now that the boom has gone bust, both in Dubai and in the United States, Dubai is stuck with a glut of real estate that no one wants to buy or rent. Creditors and markets had always assumed that when push came to shove, its oil-rich neighbor Abu Dhabi would bail out Dubai. But that assumption was called into question this week, and the resulting fear that Dubai might not be able to pay its bills sent a wave of uncertainty rippling through markets just as investors thought the worst of the global financial instability was over.
The anxiety reached Wall Street on Friday, sending the Dow Jones industrial average down more than 150 points, as investors worried about hidden debt bombs in other countries and institutions — heavily indebted nations like Greece and even Britain, high-flying emerging markets and even European and American banks that had lent Dubai money.
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 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.
On Wednesday, Dubai requested that Dubai World be allowed to skip six months of interest payments on its debt. Before then, Dubai World, the corporate face of the emirate, had commissioned the city state’s flashiest buildings, managed ports around the world and reached far overseas to invest in properties like Barneys in New York.
Now, just as Bear Stearns was a harbinger of a string of failures of overly leveraged investment banks, the concern is that Dubai could be the canary in the coal mine for heavily indebted countries. The debts of everyone, including Japan and the United States, not to mention emerging markets, have risen greatly as the countries have fought the ravages of the global recession.
“Whether you are Dubai, Greece, Spain, Ireland or the U.K., you can print as much money as you want, but at the end of the day you have to pay the interest on your debt,” Mr. Tepper said.
Dubai is one of the few member states of the United Arab Emirates that has little oil wealth of its own. It acts as the trading, tourist and financial hub of the emirates. But it was assumed that the U.A.E.’s richest oil state, Abu Dhabi, would always bail out its free-spending neighbor.
Dubai’s announcement on Wednesday reversed that presumption — even as investors fretted that Dubai risked a sovereign default that would ripple to developing nations.
And while Abu Dhabi may well want to make its more exuberant neighbor and its bankers suffer a bit for their profligate ways before it rides to the rescue, that gives little comfort to investors already wary of the region’s growing debt.
“This came as a big shock,” said Fahd Iqbal, an analyst at EFG-Hermes, an investment bank focused on the Middle East. Although Mr. Iqbal said he held to the view that Dubai in the end would avoid default, he acknowledged that the measure had severely rattled confidence in Dubai. “One of the main issues now is of credibility and the potential impact on future fund-raising, which could have knock-on effects on building and infrastructure plans for Dubai and the United Arab Emirates,” he said.
By the numbers, a tremor in Dubai should not necessarily shake the world banking community. According to data from the Bank for International Settlements, foreign banks have $130 billion of exposure to the United Arab Emirates, with Britain having the largest exposure, $51 billion. Banks in the United States have debts of $13 billion.
That is a negligible 0.4 percent of foreign banks’ total cross-border exposure, said Stephen Jen, an analyst at the hedge fund Blue Gold capital management.
In fact, Dubai World’s largest creditors are domestic banks in Dubai and Abu Dhabi.
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.
But while a Dubai default may not provoke a banking crisis, it could well spur a broader crisis of investor confidence in overly leveraged economies.
World markets did not take long to reflect this insecurity.
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 cost of insuring the debt of economies like Greece and Lithuania spiked 16 percent and 6 percent, respectively, this week. The cost of insuring Dubai’s debt shot up by 67 percent and the British pound weakened against the dollar for the week.
Greece and Britain have historically high budget deficits that exceed 12 percent of gross domestic product, with Spain not far behind and Ireland struggling with the consequences of a devastating real estate collapse.
While no one is expecting an outright default as long as global interest rates remain low — largely due to aggressive government bond purchases by central banks — concerns have been building for months that once these easing measures end, interest rates will spike and investors will become less willing to trust the word of heavily indebted governments.
For now, most of the pain from Dubai is being felt by the holders of the Islamic bonds of Nakheel, the developer owned by Dubai World that is known for the palm-themed islands it built.
On Dec. 14, $3.52 billion in Nakheel bonds come due. One of the largest Islamic group of bonds issued, the deal was snapped up by Western and regional investors. In a reflection of how sure investors were that Dubai would meet these payments, the bonds were trading at a 10 percent premium to face value earlier this week. They are now trading at around half of face value.
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