Was Dubai a surprise to many people or only to those who were gullible enough to lend it money? The gamble Dubai was taking was transparent to anyone who could see. It has no oil. So it decided to exploit the only other asset it has?location. Since few think of the deserts of the Middle East as inviting, the pill was coated with glamour. Artificial cities were to be created that were oases of luxury with hotels, golf courses, islands and greenery in the middle of sand dunes. All workers had to be imported as well as most of the consumables. This was a completely invented, manufactured paradise.
I guess one could call it a super-prime rather than a sub-prime bubble. Many moderately rich people near retirement age were tempted to buy property and the examples of football stars like David Beckham and Michael Owen were displayed for this purpose. The gamble was a big one. But it hinged on the availability of cheap credit for a long enough period for Dubai to sell all the properties even as new ones were being created. The trick in these bubbles is to manage the building and selling period to be shorter than the period over which cheap credit lasts.
Alas, even the long seven year period of the Chinese flooding the market with surplus dollars and shoving them down the throats of Western borrowers was not long enough. Partly it was the lack of a precise plan. Dubai World went beyond its own local plans and began to buy up properties around the world since it could always borrow. One glamorous project finished, another had to be launched to keep buyer curiosity whetted. The property buyers are small fish. They will take a loss in terms of capital values. They could always wait for the bubble to return.
It is the bigger lenders?banks and pension funds and hedge funds?who are worried. They just assumed that Arabs were rich and somehow Dubai World was part of the Dubai princedom. This was never clarified and only now the Dubai authorities are denouncing all the fuss as na?ve. Some may also have been given to understand with a nod and a wink that Abu Dhabi stood behind Dubai World or that the UAE federal government itself will step in if needed.
Not so, alas. The UAE central bank protected the local banks against any run, but that was all. Neither the Dubai government nor Abu Dhabi nor the UAE is standing behind the debts of Dubai World. The creditors will have to wait patiently till the smoke clears and grab whatever fraction they can get. It is entirely their fault. They walked into a gamble with open eyes. They did not read the fine print of the contracts they were signing though most of these are hundreds of pages in length. They were taken for a ride and are now fuming, but surely at their own stupidity more than anything else.
That said, it must also be added that the manner in which the debt default (for that was what it was) was announced was spectacularly bad PR. To go public on the day before markets were to be shut in the US (Thanksgiving) and the Middle East (Eid) looked like deliberate double dealing. This meant that London and Asian markets took the brunt of the shock. Someone should have advised the top leadership that this is not the way honest people do business. Even if all the debts are cleared, the trust in Dubai World has now vanished. Unfair though it may sound, the entire region will find it hard to borrow with the same ease.
It is too early to say whether this shock will delay the recovery. There have all along been two parallel crises?real output recession and financial market dysfunction. Massive re-capitalisation of banks in the US, the UK and EU stemmed the bleeding from the financial dysfunction. Many banks are repaying what they were lent if only to escape close surveillance of their bonuses. Real output cycle has turned up, output growth is no longer negative and unemployment may have reached its peak.
The impact of Dubai would be on the financial markets that are still fragile. The actual losses will be manageable but there will be echo effects. Government debt of countries such as Greece, Ireland and Iceland will become costly and this may extend to even sounder economies in the OECD. If debt became difficult to market, then the output recovery will be weakened.
It is a delicious paradox that the safest markets are in the so-called ?emerging? economies and the risky ones are in the developed ones. And this is just the beginning of the long rebalancing of the world?s economic power that will mark the early decades of this new millennium.
?The author is a prominent economist and Labour peer
