The Dubai Gambit

Although we just wrote about Dubai and its impressive level of debt - not to mention its impressive malinvestment of its resources - the Emirate has made a manoeuvre which we didn't even think of: declaring the debt of Dubai World not backed by government guarantee. From the BBC:

"[Creditors] think Dubai World is part of the government, which is not correct," said finance minister Abdulrahman al-Saleh. "Creditors need to take part of the responsibility for their decision to lend to the companies."

Clever, very clever; it seems to us that Dubai is looking to have its cake and eat it too, after a manner of speaking. They got their theme parks and little islands, and now the investors can go stick it wherever they'd prefer the pain. And if those investors attempt to foreclose on the assets of Dubai World, they just might run into the little problem that said parks and islands are property of the Dubai government, or perhaps the Abu Dhabi government; in other words, foreclosure is not happening, because we really don't think an UAE court would care to strip a sovereign government of its assets. Certainly not for foreigners, and the latest incident with the Swiss banning minarets will likely not help the situation.

A thought arises from the move, which we give the same title as this post: the Dubai Gambit. We'll put it in the general terms for starters. A nation's Government spawns this enterprise (we'll use the U.S. term of Government-Sponsored Enterprise, or GSE, with apologies for such Amero-centrism), and lets it just toddle along, doing its thing. As a GSE, it would seem to investors that the GSE enjoys an implicit Government guarantee; the Government made it, so why wouldn't it keep it going if times were tough? So, investors cheerfully pile into the debt of this GSE, because from their perspective it's just as good of debt as sovereign debt.

But surprise! It doesn't say anything anywhere in the GSE's charter (or what have you) about a Government guarantee. That means the Government, at its fickle discretion, can either help out the GSE in times of trouble, or not. The average investor, being apparently rather dim-witted when it came to reading fine print, was speculating much harder than he or she thought; the money he or she plopped down for the GSE's debt might never come home from the front lines of the Free Market. It's a messy place, we hear, and casualties can be heavy.

Bad times come along, and the GSE gets into some serious trouble. Investors start thinking "Boy, I be sure glad that thar GSE's got some sort of gum'ment guarantee or some such. I's real smaaart," and patiently sit on the deck of their double-wide trailer waiting for the cheque from the Government to make them whole. Grandma Kettle's rocking chair creaks as she loads up the shotgun to take aim at a stray dog; the hole in the roof gets a little bigger; no Government cheque comes in.

That's because the Dubai Gambit was brought into play; the Government decided the GSE was not, in fact, going to enjoy a bailout. In the real world, this would probably happen when such a GSE was in such horrible shape, that the Government would have risked its own credit rating to support the malinvestment of the investors, and the GSE's own malinvestments. GSE debt goes from being 'as good as Government' to 'someone has to do something about this!' overnight, as the bonds go belly-up. Investors are left footing the bill for someone else's good time, and the Government comes out, theoretically, smelling like a rose, at least to the credit markets.

As this meltdown of the GSE is underway, the Government finally steps in, but not in the way the investors were expected. Instead of providing a backstop for the full value of the GSE debt, the Government starts Agency X, with the explicit goal of winding down the GSE's debt. With a pre-packaged bankruptcy agreement - and a sufficiently... agreeable... court system - Agency X gets to cherry-pick the good assets of the GSE, and leave the GSE with all of its liabilities. Investors in the failed GSE would get Agency bonds worth pennies on the dollar of their original GSE debt, and the Government gets to have at least something for its efforts.

We fully expect Dubai to do this manoeuvre, or at least something like it. If it seems far-fetched to you, dear Reader, please consider the shenanigans surrounding the General Motors bankruptcy fiasco in the United States. The 'old' GM went into bankruptcy, gave its few good assets to the 'new' GM (owned by the U.S. Government, the Crown in Right of Canada, and a few other favoured parties), and then left its legacy of toxic waste dumps (or, 'factories,' as they are charmingly misnomered) and other such massive liabilities upone the shoulders of now wiped-out investors; the 'new' GM is in the clear. This, in civilised countries, is typically considered unlawful conveyance, but since the Federal Government was involved, such trivialities were easily brushed aside.

The Dubai Gambit is, at its core, entirely designed to have the Government - any Government - protect its credit rating at all costs. Dubai seems to be very much conscious of that factor, as why else would the Emirate have explicitly withdrew any implicit Government guarantee? Dubai World et al. is a mess financially, and it would probably bring down the Government if it tried to back the enterprise's debt for its full value. At pennies on the dollar, as it were, Dubai might be able to convince the UAE central bank, or Abu Dhabi, to bankroll a resolution of the fiasco; Dubai keeps its sovereign credit rating, the UAE and Abu Dhabi look like heroes, and investors in Dubai World don't feel quite as raped as they otherwise would have.

The question is, if Dubai makes this Gambit work, and to paraphrase Tom Lehrer, who's next?

Windfalls and the Collapse of Dubai

The post didn't come out right when first posted. Paragraphs have been corrected, with apologies.

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It seems that the banking system of the United States got all better for the Thanksgiving holiday, because the FDIC did not close a single bank. Frankly, we wonder how the FDIC has managed to keep its reputation as high as it is, because this sort of politicisation is completely outrageous. As we understand it, the FDIC is tasked with protecting depositors of banks, not gauging the public mood for whether or not it should protect said depositors. This inaction is completely outrageous, in our humble opinion; we wish others were outraged, too. It does not make us feel confident that our banks aren't complete trash-heaps, and we wonder just how safe “[every] single penny of deposits” really is.

But at any rate, let us turn to world events. Dubai, we read, totters on the brink of default, and the rest of the world begins to panic about all the debt from the best skiing land the far side of the Rub' al Khali. Those little private islands aren't looking so hot as investments right about now, we'd hazard to guess; although, if we'd be permitted to moralise for a moment, they seem to us to be the logical conclusion of the insanity of suburban development. We honestly can think of nothing more ridiculously 'exclusive' than one's own, artificial island. The situation with Dubai is an interesting one, from a malinvestment point of view.

Let us be honest here: we fully expect anyone and everyone who invested in Dubai's madness will end up losing every single penny they ever invested. It will probably be a very fascinating blow-out to watch, but we'd like to take a look at how, exactly, this malinvestment probably came about. We are supporters of the notion of Peak Oil; i.e. the idea that the economically-extractable amount of oil in the world is finite, and will result in a permanent decrease in the availability of a potent energy source to fuel human economies. This is not a popular view, as we're sure you are aware; in fact, to even breath the words 'peak oil' in a sentence, and not immediately ridicule the concept as lunacy and defeatism, is to give suspect to one's character.

The popular discourse, as we understand it, is either permanently-increasing availability of cheap oil, or the latest stupidity called 'plateauing,' where oil reaches a level of production which can be maintained indefinitely. If it is taken as given that oil will never run out, then Dubai seems like a great investment, because the Emirate would forever become richer and richer; better invest now, before it gets even more expensive!

No one, it seems, stopped to question this notion of infinite oil before they leveraged themselves to the hilt to invest in Dubai. If, indeed, oil has peaked, which we believe it has, Dubai is probably going to be getting permanently poorer, at least in the long run. Hence, the grand malinvestment in Dubai, Dubai World, et al.

Dubai's madness – for really, what else could it be called, other than wilful insanity? – was facilitated by its endowment of oil. We'd like to present that oil as a windfall, for conceptual purposes; it was a one-time shot at something, granted by a quirk of geology and human development to the Emirate. They took that windfall and blew it on skiing in the desert and artificial islands shaped like palm trees; a grand gesture, we think, to the stupidity of humanity.

Norway, on the other hand, took their oil windfall and tried to use it for better purposes. As we understand it, they tried to use the vast wealth which came from the one-time exploitation of their oil to improve the quality of life for all Norwegians; something that Dubai has not done, and will never do. Quality of life in Norway will, we think, continue to be quite high, long after Dubai is perhaps consumed by sandstorms, or at least reduced to a ruin of its former self. The differences, we posit, between wise investment of a windfall, and a windfall-driven orgy of conspicuous consumption, will probably not be better evidenced than by these two nations.

The collapse of Dubai will likely serve as a model for future national collapses in the 2007 Depression. Those nations which have a windfall, and have already blown it, are probably going to go the way Dubai goes; namely, somewhere very dark and scary. It should serve as a stern warning to those nations which still have a windfall they're in the process of blowing, because it's not too late to change course. Smart investment of resource windfalls, such as oil, will be increasingly paramount in the future.

In this category, we're thinking of the resource-heavies of the world, and not the silly notion of BRIC which is presently flying around (Brasil, Russia, India, China); India and China, in our opinion, are going to blow out along the lines of Dubai. Instead, we'd like to present our pet notion of CARB: Canada, Australia, Russia, and Brasil. These four nations apparently enjoy fairly large resource endowments, which have not yet been economically exterminated; if husbanded, life in the 2007 Depression might not be quite so bad in CARB, as opposed to, say, Dubai.

The concept of CARB is one which we would prefer to address in a separate post, to avoid accusations of wind-baggery. Instead, and in closing, we'd like to point out the nation which has blown its resource windfall far more than Dubai could ever hope to accomplish.

Go on, guess. We dare you.

The New World was beyond a shot in the arm to the European economy, when it first began colonising the new continents; it was like speed, angel dust, crack, LSD, and crystal meth all rolled into one, injected directly into the brain. But before that granddaddy of all economic stimulus could be used for the benefit of European colonial powers, the United States came along and had the indecency to clam a vast swath of the New World for its own. From there, it proceeded to burn through the incredible, mind-boggling amount of wealth which was to be had, to build... umm... wait, we know this one. Oh yeah, suburbia, and the most expensive military the world has ever seen. Right, sorry.

Simply put, however bad Dubai will become, we will not be the least bit surprised if the U.S. ends up being far, far worse. It had a much bigger windfall, which it blew over about two hundred years and far too many pointless wars. The era of Warren Buffet's 'never bet against America,' we posit, is over. There is money to be made shorting the U.S. and investing elsewhere, not the other way around.