The property bubble was a global phenomenon. Prices rose to ridiculous levels almost everywhere, from Britain to Latvia to the US.
But few places saw a bubble quite as insane as Dubai’s. We wrote countless pieces in MoneyWeek magazine, warning people not to invest. There was an almost limitless stream of new supply coming on line, with no apparent care for infrastructure or aesthetics. And it was being ramped left, right and centre as the big ‘fly-to-let’ destination.
So it’s little wonder that Dubai was one of the hardest hit when the bubble burst. But then Dubai’s sensible big brother, Abu Dhabi, stepped in with a loan. It seems everyone thought everything would be OK.
Turns out they thought wrong…
A nasty reminder of Dubai’s debt problems
Dubai was built on the back of low taxes, cheap credit and petrodollars. And let’s not forget, slave labour (if you haven’t already seen this expose by Independent journalist, Johann Hari, it’s well worth reading: The dark side of Dubai). So when the cheap credit vanished and the oil price collapsed in 2008, it was always going to be one of the first places to suffer.
And suffer it did. David Wighton in The Times points out that around 400 building projects with an estimated worth of more than $300bn are thought to have shuddered to a halt, as property prices have tumbled by around 60%.
But then, just like everyone else on the planet who built their livelihoods on the credit bubble, Dubai found a benefactor to bail it out. In this case it was Abu Dhabi (the capital of the UAE), which came along and saved its fellow emirate by buying $10bn-worth of government bonds.
Sure it didn’t do much for Dubai’s overall debt load (in total, the emirate – including state-backed companies such as Dubai World – owes more than $80bn). But it sorted out its short-term liquidity problems. So everything was sort of fine. Building came to a standstill of course. But there was a lot going on in the rest of the world, so people forgot about Dubai. Things started to get better elsewhere too. Risk appetite started to pick up. Stock markets bounced across the globe. Investors started to think: “What was all that fuss in 2008 about anyway?”
Then yesterday, state-owned conglomerate Dubai World, which is responsible for about $60bn of that $80bn in debt, turned around to its lenders and said: “You know that money you gave us? Well, we need a bit more time to pay it back.” Despite Dubai’s clear problems, the news came as a shock, to say the least. The cost of insuring against governments defaulting on their debt jumped, not just in the Emirates, but across the Gulf, reports Bloomberg.
And it couldn’t have come at a worse time
So what’s happened? The Government of Dubai has asked Dubai World’s creditors to agree to a six-month standstill on the conglomerate’s debts “until at least” 30 May 2010, while the company is restructured. That’s worrying enough. But what also concerned investors is that the Government of Dubai had also just raised a further $5bn from Abu Dhabi.
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Now, according to FT Alphaville, traders had expected this money to be used to repay $3.5bn in bonds issued by Dubai World’s property unit, Nakheel (the company which built the artificial palm tree resort much beloved by footballers). This $3.5bn loan falls due on 14 December. But now it won’t be repaid until at least the end of May.
And just to add the icing on the cake, Dubai has now shut down for Eid, until early December, which could mean further details will be a while in coming.
As RBS analyst Okan Akin told City AM: “The timing could not have been worse.” After all, it’s not as though Nakheel investors have been given a lot of notice here. If you’d been planning on that money being paid back soon, you might be a little annoyed, to say the least – particularly as Dubai has been swearing for months that it would meet its obligations without any problems. The Emirate’s ruler, Sheikh Mohammed Bin Rashid Al Maktoum “publicly pledged his support for the group and its obligations” earlier this month, notes the FT’s Lex column. “Investors, perhaps foolishly, took him at his word.”
Norval Loftus, head of Islamic debt at Matrix Group, tells Bloomberg: “The worst case scenario will of course be involuntary restructuring on the Nakheel security that brings into question the entire nature of sovereign support for various borrowers in the region.”
What’s that mean? As Moody’s put it: “Nakheel… sets a major precedent for a high-profile, seemingly strategic company facing debt repayment difficulties and thus relying on the government for support. A restructuring of its obligations would indicate that the government is prepared to allow a government-related issuer to default on its obligations.” In other words, this case may show that lenders can’t depend on the notion that governments will always make sure that apparently state-backed companies will repay their debts. And that would make an awful lot of other Dubai-backed debt look far riskier than investors have been accounting for.
A valuable warning for the rest of us
What does Dubai mean for the rest of us? Well, it’s a valuable warning that there are nasty little financial time-bombs lurking everywhere across the world. Already we’ve been reminded by credit ratings agencies, that a huge number of the world’s banks remain under-capitalised.
It’s also a very important warning that you can’t trust governments. They’re prone to covering things up for the “greater good” – which is government-speak for “covering our backsides”. Given the role of the state in markets across the world right now, that’s not very reassuring.
We’ve been wondering when investors would get the nasty shock that reminds them that the world is a dangerous place. This could be just the beginning.
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