Dubai – The Train Wreck That Was Waiting To Happen

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By Greg Peel

Icarus flew too close to the sun, so the myth tells us, causing the wax holding his wings on to melt and Icarus to fall fatally to earth. Respected commentator Dennis Gartman drew upon this myth overnight in his daily Gartman Letter, noting that whenever one sees a rush to build ever taller and taller skyscrapers, it is a clear sign a disaster is coming.

One is reminded of the Empire State building – for more than forty years the world’s tallest. It was built in the twenties and completed in 1931 – just in time for the Great Depression. Ironically, the builders needed to add a dirigible docking tower at the top to ensure the Empire State would be taller than the nearby Chrysler building, also newly completed. It is here where the Hindenburg would tie up.

The tiny emirate of Dubai has spent the last several years of boom-time taking the concept of oasis in the desert to new extremes. The Palm Island marina, manicured golf courses, multi-lane highways with barely any traffic, and buildings so tall they make the Empire State look like a townhouse, were all part of the dream. One would be forgiven for assuming this is typical emirate excess built on an abundance of petrodollars. But the truth is unlike neighbouring Abu Dhabi, Qatar or Saudi Arabia, Dubai has no oil, gas or anything tangible. Outside of royalty, the people of Dubai are dirt poor. The City of Dreams has simply been constructed as a financial centre – a conduit for the developed world to do business in the Gulf.

It has been created by conglomerates of state-owned enterprises, and financed entirely on debt. One of those conglomerates – Dubai World – owes US$60bn of which US$50bn in refinancing is due in 2010-11.

Last night Dubai World announced it will ask its creditors for a “standstill” on debt repayments until “at least” May next year to allow time to attempt to restructure the debt. A major member of the conglomerate is property developer Nakheel which has suffered heavily from an unsurprising collapse in Dubai property prices post-GFC. The Dubai government has now authorised its Dubai Financial Support Fund to spearhead the restructuring “with immediate effect”, reports the local Khaleej Times.

Khaleej Times: The restructuring effort “basically aims to ensure the continuity of the company and will address the financial obligations of everything in the group,” the Department of Finance spokeswoman said. “They need some time to actually get the restructuring underway, she said. The department left open the possibility that Dubai World may need to request a future extension beyond May 30 of next year.

The announcement was clearly timed to coincide with the beginning of the Eid al-Addha festival, an Islamic feast which closes all Middle Eastern markets for four days. Thanksgiving in the US would also have come into consideration. At least this provides a “breather” and allows for a measured response once markets reopen, rather than the risk of sheer panic.

The panic was nevertheless felt in the UK, home to Dubai’s biggest creditor banks. Led by the financial sector, the FTSE 100 fell 3.2% in London last night and Europe followed suit. Safe havens were once again sought in government bonds, Swiss francs and US dollars, although the real dollar response will have to wait until tonight when US markets re-open (note the NYSE will close at 1pm local instead of the usual 4pm). Gold is down in the Asian session but only mildly, as its own safe haven status offsets the impact of a rising greenback.

Clearly the Australian market has copped a knee-jerk hiding, led by the banks. Already ANZ ((ANZ)), for one, has come out to confirm its lack of exposure to Dubai. However the ramifications of the potential next step in this process – a default on Dubai sovereign debt – would be deeper than just a matter of who has actually leant the emirate money.

Dennis Gartman: “Most importantly, we fear that this news might be the news that tends to push equities around the world over the edge; that brings on a trend toward global protectionism and that pushes the US dollar materially higher - and perhaps violently so. We hope we are wrong; indeed, we pray that we are terribly so, but we fear that we are not. The long Thanksgiving holiday will give everyone the chance to collectively breathe and consider what has happened in the Gulf. Perhaps cooler heads shall prevail as the next several days pass, and perhaps this situation will simply devolve into memory and into nothing; but we fear that this is a far larger story than it appears even this morning and if it is we may be surprised by how strong the dollar becomes – and how swiftly it does so.”

The risk here is that global credit markets, which have only recently began to return to any level of risk appetite, let alone “normal”, will freeze once more in renewed panic. ANZ may not be directly exposed, but a fresh jump in credit spreads would result in funding cost increases for all Australian banks. This would eventually flow to more independent increases in mortgage and other lending rates, although if worse comes to worse, the RBA may not hike again in a hurry.

As for the UK, the situation is very grim. This week’s 13 billion pound capital raising by a struggling Lloyds Bank was evidence enough of the parlous state of British banking, while other British banks are now half-owned by the government.

As for other sectors and companies within the Australian stock market, GSJB Were pointed out this morning that fears surrounding Leighton Holdings’ ((LEI)) Dubai exposure are unfounded given the breadth of Leighton’s exposures elsewhere in the (oil-funded) Middle East and in Australia. The Dubai factor has been already discounted into the share price. JP Morgan also noted this morning that Asciano ((AIO)) may stand to gain if competitor DP World, part of Dubai World, falters.

Returning again to potential credit spread blow-outs, these have already been suffered by the neighbouring emirates and Saudi Arabia in an immediate response from the world to the Dubai announcement. Abu Dhabi, for one, has already helped to bail out Dubai World previously this year. Given these oil-rich nations would likely not be very pleased with a sudden jump in funding cost, it would not be too much of a stretch to assume they may get together to sort out Dubai’s immediate problems.

This is no storm in a tea cup, and has potentially severe ramifications for the confidence of a world only just starting to get back on its feet following massive government and central bank stimulus. A swift and positive conclusion would prevent another Lehman-style response, but investors have now been reminded the world remains in a fragile state.

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