Dubai Debt Debacle

When a bunch of American bankers woke up last Thursday, I hope they found more to be thankful for than just a traditional turkey dinner. It’s thought that the American banks will have less exposure to Dubai World than most European or Asian banks – although the American banking industry is known to hide a thing or two up their sleeves. Dubai World is asking creditors for a “standstill” – meaning they want the interest to stop accumulating on their debt. It’s a polite way of saying they can’t afford the interest payments anymore.

Dubai is one of the seven states that make up the United Arab Emirates (UAE). Dubai borrowed heavily to finance a building boom supported by high oil prices. They now lay claim to the world's tallest building and an island in the shape of a palm tree – at least General Motors went broke building cars. The capital of the UAE is Abu Dhabi. It’s unlikely that Abu Dhabi can come to the rescue. Just last February Abu Dhabi injected $4.5 billion into five banks that were coming under financial pressure when the real estate market shifted. Bailing out banks seemed to stop the U.S. government from bailing out General Motors.

Dubai World is said to be in debt for $60 billion, although some reports put the figure much higher at about $90 billion. Even at the low end, that figure is equal to all the foreign direct investment in the UAE. (Foreign direct investment is all the money that foreigners invested in UAE.) By comparison, the direct investment of all UAE residents in other countries is less than one half that amount (about $29 billion at the end of December 2008). But don’t think that means that Dubai World’s investments are of little consequence outside the Gulf region. Recent projects include ports in London and Vancouver. DP World was at the center of a controversy in February 2006 when they announced the purchase of a firm that oversees operations at six U.S. ports – DP World subsequently sold them off.

Dubai World is the UAE government’s investment conglomerate. That makes this a crisis in sovereign (public) debt – possibly only the first shoe to drop in the coming crisis I warned about back in July. Hope you don’t get tired of hearing me say “told ya’ so” – I suspect it will happen with increasing frequency during the next twelve months. The real problem with defaulting sovereigns is that there is no Chapter 11 bankruptcy process for them, like there was for General Motors. When a country defaults on their debt, they just stop paying – “governments can change the rules on a whim.”