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Dubai Debt Debacle Rattles Markets, Confidence

In Dubai, massive banners advertising available space adorn the sides of nearly every building. Hundreds of cranes that just last year were working around the clock now stand idle all day. Unfinished sky scrapers seem almost as common as completed ones. And workers who were recently flooding in from around the globe are now beginning to leave.

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The Emirate of Dubai, one of seven sheikdoms that form the United Arab Emirates (U.A.E.), has been badly damaged by the economic crisis. Property prices have collapsed, losing half of their value. The low-interest debt-fueled extravaganza in the desert fiefdom is screeching to a halt, at least for now.

Dubai World, a massive state-owned conglomerate responsible for many of the emirate’s audacious real estate projects, announced last week that it was seeking a six-month freeze on about $60 billion in debt repayments. The government-run company will be restructuring around half of the debt so far, officials stated Monday. One of the firm’s construction arms, Nakheel, asked the Dubai stock market to suspend its $5 billion worth of Islamic bonds until it could “fully inform the market.”

Following the announcement of the debacle, commentators and some analysts became worried that the crisis could set off a “tsunami” or even a “domino effect” that would roil world markets again. The announcement was compared to everything from Argentina’s default in 2002 to Lehman Brothers’ collapse last year. Stock markets around the world dropped sharply as investors tried to figure out what it all meant.

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“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,” explained analysts for Bank of America after the news broke. Other banks issued similarly dramatic warnings, while even the Obama administration announced that it was “monitoring” the situation.

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With the potential for a default on the debt, rating agencies including Moody’s and Standard and Poor’s immediately stepped in and downgraded several Dubai state entities. The debt restructuring "may be considered a default under our default criteria, and represents the failure of the Dubai government (not rated) to provide timely financial support to a core government-related entity," said S&P. The cost of insuring Dubai debt also soared, as did protection for Abu Dhabi debt.

The U.A.E.’s central bank, meanwhile, pledged to support national financial institutions and local branches of foreign banks with increased “liquidity” (fiat money). But finance officials in Dubai warned Monday that the government was not responsible for the company’s debt. "Creditors need to take part of the responsibility for their decision to lend to the companies," declared the director general of Dubai’s Department of Finance. "The company received financing based on its project schedule, not a government guarantee."

It turns out British banks, some owned by taxpayers, were particularly exposed, with some estimates claiming they own as much as $50 billion worth of Dubai debt. American banks were left relatively unscathed, though Citibank does have some investments in the emirate. Speculation abounded about whether the government would end up stepping in to bail out its company, or whether Abu Dhabi, the richest emirate in the U.A.E., would offer some assistance. But so far, Abu Dhabi has only pledged to selectively support some of the debts – not extremely reassuring to the market that had assumed an implicit government guarantee existed because of the nature of the conglomerate.

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December 3, 2009