Dubai's grim warning to unwary investors

By MoneyWeek Editor John Stepek Nov 26, 2009

John Stepek

Comments (17) Print this article

Palm Jumerirah © Nakheel/Bloomberg

Palm Jumeirah: developer in deep trouble

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.

Special FREE report from MoneyWeek magazine: When will house prices bottom out - and how will you know?

  • Why UK property prices are going to fall 50%
  • When it will be time to get back in and buy up half price property

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.

Our recommended article for today

Eight ways to profit from the eventual upturn

Once economies emerge from recession, employers will take on more staff. That's good news for recruitment companies, says Tom Bulford. Here, he picks eight recruiters that should benefit once the rebound gathers pace.

Comments (17)

Published in Economics | More articles by John Stepek

Share with:More

TwitterLinkedInViadeoFacebookYahoo! BuzzredditDiggDelicious

Related articles

Comments

Leave a comment

  • 1. Mike

    (26 November 2009, 12:28PM)  Complain about this comment

    Where were you saying that bond strike was going to start?

    Sorry couldn't resist. I know you have to be slightly sensationalist but the downside of airing opinions is there is risk on both sides.

    Suppose the equation is whether embarrassment outwirhs pride, or vice versa.

  • 2. Gary

    (26 November 2009, 01:27PM)  Complain about this comment

    Hi John,
    I think your articles are extremely interesting and pull no punches.
    It's all quite scary isn't it. Governments postponing the "day of reckoning." Whatever next?
    Personally I've always suspected that the G20(G7) meetings have been a bit of an old boys club. Who's to say if they haven't come to a collective agreement that they will all refuse/default on their debts at the same time? A bit like clearing the slate and starting all over again with no comebacks!

  • 3. Frank

    (26 November 2009, 01:33PM)  Complain about this comment

    Why the flight to safety of government bonds on this news when you are saying that you can't trust goverments.

  • 4. Anna Mika

    (26 November 2009, 02:01PM)  Complain about this comment

    Why is it that expats who default on payments are threatened with jail and are then humiliated further if they cannot payback by being put into jail and then deported?

    Remember the cars being dumped and owners flying home or elsewhere? So true...one only needs to take a look at the number of vehicles that have been left gathering dust for months to realise the extent of what is going on!

  • 5. J Hughes

    (26 November 2009, 02:44PM)  Complain about this comment

    This comment has been removed by the moderator

  • 6. phil stevens

    (26 November 2009, 03:17PM)  Complain about this comment

    The fact is, we are in the worst rescession in memory, and i dont really think we have seen the start of it, there is still alot of bad debt, private debt and dont forget the government has the VAT low and has quantitive easing in the mix too..... Money week report alot of doom and gloom, but unfortunately they are right! We are know where near out of the woods yet. But on the positive side its nearly xmas holidays and im out on the lash with the boys tomorrow night! :0) ye har...... the future is bright indeed! :0)

  • 7. NVP

    (26 November 2009, 03:22PM)  Complain about this comment

    The whole Dubai building spree was like the Emporers new clothes....some people believed the hype and bought the dream, whilst the logical investors did their own (over) capacity calculations and realised this was unsustainable in the Long term - bubble or no bubble

    NVP

  • 8. JJ

    (26 November 2009, 04:13PM)  Complain about this comment

    Just think what would happen to the U.S. if the U.S. Dollar wasn't the reserve currency and wasn't totally fiat allowing the Fed to print unlimited amounts.We would be in a much worse situation than Dubai.I suspect that a day of reckoning is on the horizon for our bankrupt country.Got GOLD?

  • 9. Wozak

    (26 November 2009, 06:30PM)  Complain about this comment

    Nial Ferguson the Harvard Economics Historian said recently that the USA would ultimatly default on its debt. Now that is scary. If you think about it if your debt is held by foreigners it is easier for politicians to default rather than upset the electorate.

  • 10. Edmund Butler

    (26 November 2009, 07:10PM)  Complain about this comment

    What J Hughes said is one side of the story. I do sympathise with you, it is very hard to take, but no use in buyring our heads in the sand.(no pun intended) It is never too late for us ordinary people to take control over our own countries and be responsible. Capitalism is running out of steam and cannot survive on wishful thinking. All this greed will come back to haunt everyone. Financial collapse is imminent. Other countries such as Ireland will follow. Governments are not totally to blame. We put them there, and we knew what they were doing. Smooth talk from Obama has not delivered to the U.S.

  • 11. Dr. M A Jabbar

    (26 November 2009, 08:21PM)  Complain about this comment

    This was half-expected. people crowded into Dubai properties for qucik bucks knowing fully well that such a race leads to nowhere. Dubai is rich, but that does not mean they will honour the debts of property companies. Investors need to weigh risks and gains. I am sure things are going to get worse once the interest rates around the world is going to get much higher. That will be the crunch time.

  • 12. Kim

    (27 November 2009, 12:34AM)  Complain about this comment

    The whole debacle just goes to show that economic analysis in isolation is utterly meaningless. Social factors matter, and Dubai has quite a few negatives.

    Looking at Dubai as a 'product' over the long term, I can't see how it could possibly fill even the existing building stock. It has little but sand, skyscrapers, and debt. There's little natural capital (a bit of oil, perhaps), no human capital (if it were full of Japanese, you could at least be sure that they'd design and make stuff that people would pay for), and an oppressive culture. As a fun in the sun destination, it's far from everywhere, and not that fun to begin with.

    I honestly don't think the place will recover in my lifetime.

  • 13. The Big Man

    (27 November 2009, 10:19AM)  Complain about this comment

    You can draw a line from Blackpool to Majorca to Florida to Dubai re holiday destinations for brainless idiots with too much cash and zero taste.

    Dubai is doomed.

    Read the "Dark Side " article linked to in the article above and see how it's a society based on slave labour.

    If you made anything from Dubai, feel ashamed, very ashamed!

  • 14. KKumar

    (28 November 2009, 11:52AM)  Complain about this comment

    So what next?....if Dubai World is allowed to "standstill" on the debts can the individual expat borrowers be also allowed to do so..since they are anyway owed money by the government for the contracting job that was done for the government...and now the government says....hey guys, thank you for the job well done....can you now leave the place...forget about the payment...this place is ours afterall!!......like in HSBC, 70% of their customers have written into reschedule their payments and HSBC for that matter has withdrawn 100% of the overdraft limits for their customers!...great going!

  • 15. Kazumab

    (28 November 2009, 01:58PM)  Complain about this comment

    The sheep's clothing is coming off. I don't know why this is news. Anyone who lives in Dubai or knows someone who does is aware of the deluded hypocritical lifestyle people have been livng other there. The nation state is built on nothing but the illusion of money - fiat currencies and depleting commodities (oil). On top of it, they've built it up while stepping on the necks of the poor and downtrodden. I was only a matter of time before the whole thing blew up, and this is only the beginning. Things will get much worse.

    Why in the world would any human being build a luxury ski resort in the middle of a desert??????????????? How useless and unsustainable is that???????????????????

  • 16. Bob Goodwill

    (29 November 2009, 04:07AM)  Complain about this comment

    John,

    Interesting article on Dubai and its demise. The only thing I would question is your statement that it was partially built on the PetroDollar. Dubai has in fact very limited natural resources, including Oil & Gas, hence the claimed collapse in the oil price would have minimal effect on the overall state of Dubai's wealth. Even so oil prices have been consistently higher than those in existance at the time of Dubai's rapid expansion over the past 10years.

  • 17. Stephen B

    (29 November 2009, 09:19AM)  Complain about this comment

    Dubai is a unique story, and it shouldn't put people off investing in the other Emirates like Qatar. The reason it expanded so aggressively was because it does not have its neighbours oil resources. The rest of the region with its vast oil reserves - well its quids in for them for the next couple of decades.

Leave a comment

This will be the name displayed with your comment.

This helps us verify comments are genuine. It will not be displayed anywhere on the site and is stored confidentially.

Please keep your comment to within 1,000 characters, and relevant to the main topic. Comments not directly on topic will be removed.

captcha To prevent spam-related comments please enter the characters shown in the CAPTCHA box to the left.

By leaving a comment you accept our terms and conditions.


FREE - MoneyWeek's daily investment emailJohn Stepek

Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.