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The Dubai Real Estate Boom Depends On Massive Debt

Dubai World, one of the world’s largest debtors, has asked its banks for a 6 month moratorium on debt service to avoid possible default. The extent of Dubai World’s default risk remains murky, but in Britain alone, Standard Chartered, HSBC (HBC), Royal Bank of Scotland (RBS) and Barclays (BCS) are said to hold at least $30 billion of Dubai Word’s estimated $90 billion debt.

Dubai

Dubai Bubble Bursts

To assemble a banking consortium sufficient to serve the largest international clients demands that banks work together to identify and qualify large projects. This is not something new, nor inherently dangerous, for syndicating loans among many banks reduces risk for participating institutions while also serving the interests of  large financing projects whose aggregate demands for credit can, and often do, exceed the loan authority of even the largest banks. One such case is the immense development of Dubai by one of the world’s largest debtors — Dubai World.

Dubai is a city state within one of the the seven ( states ) emirates of the United Arab Emirates (UAE).

Dubai is ruled by Mohammed bin Rashid Al Maktoum, who also serves as the Prime Minister and Vice President of the UAE.

The emirate’s revenues derive from tourism, property and financial services.

Property and construction gave rise to a large-scale construction boom financed largely by banks in Europe, Asia and the United States.

Dubai promotes itself as a Global City and business hub.

When Banking Turns To Gambling

Dubai Island Hotel

Such arrangements are fraught with problems. Especially when the loans are of immense size, or made to borrowers who have the appearance of undergirding financial strength, that is neither proven nor necessarily sustainable.

One such massive financing project arose from the decision by Dubai to change its arid desert lands into a major international metropolis. While most projects were financed separately, the overall impact of bank debt in the $80 billion range has been to make some of the world’s major banks effectively partners in one of the biggest real estate bubbles in history.

In the last year, the shakeout in international credit markets produced instability in real estate world wide. Real estate, especially commercial, is driven by the extension of credit. For Dubai World, the effective  collapse of its real-estate values has been sharp — and for the moment, without evidence of reversal. The implications for its creditors is one of significantly increased risk. Risk from default. Risk from an extended downside in commercial real estate. Risk from failing to keep the project afloat until recovery.

Expectations Of Bail Out

The reality is that international banking has risk characteristics very different from traditional commercial real estate  banking practices. At its best, the Dubai World debt is guaranteed by stable and creditworthy governments. At its worst, dependence on governmental bail-out by party(ies) not already involved strongly suggests that the stable credit worthy government may be neither.

There is no reason to believe that Dubai itself is, for the moment, not credit worthy — given the recent commitment of Abu Dhabi to add its faith and credit to as much as $10 billion of the risk. If this seems a bit risky consider that the banks know that they are not ultimately at risk — you are.

No mater whether Abu Dhabi is ever asked, or willingly covers Dubai World debts, the overall banking risks arising from this and other international syndication packaging is better described as gambling, not banking. Should Dubai World eventually default the repercussions could adversely impact banks and governments in nations around the world.

Good Money Going After Bad

Dubai's World Trade Center

Speculative international financing are considered bubble risks by some economists. The term describes the unpleasant reality where there is little or no backup debt service capacity by principal debtors.

Where there is no backup debt servicing potential, banks are faced with making many new decisions. Among the most daunting, and fraught with risk, is whether to risk losing some or all of a bank’s loans, or to accept modification of terms, or even worse, possibly loaning additional monies.

Experienced bankers don’t like any of these options, for whichever choices are made have the feel of throwing more good money at unsolvable problems long after making what have become troubled loans.

The problem isn’t that debtors haven’t the capacity to service their debt as long as the assumptions on which the loans were made remain valid, but rather the increased risks when some of the assumptions turn invalid. Or, in certain cases, such as the massive real-estate bust unfolding in Dubai, when all of the assumptions turn invalid. Perhaps, permanently.

Britain’s BIg Banks At Risk

Dubai World, one of the world’s largest debtors, has asked its banks for a 6 month moratorium on debt service to avoid possible default. The extent of Dubai World’s default risks remains murky, but in Britain alone, Standard Chartered, HSBC (HBC), Royal Bank of Scotland (RBS) and Barclays (BCS) are said to hold at least $30 billion of Dubai Word’s estimated $90 billion debt.

The implications for U.S. Banks is troubling because Band Of Brothers institutions routinely make loans, issue guarantees and trade sometime incomprehensible financial instruments with one another. Following announcement of Dubai World’s problems, some U.S. banks including CitiGroup and JPMorgan were down after some overseas markets retreated as much as 2% to 4% on Friday, November 27.

While there appears good reason to believe that the Dubai World problem could be alleviated by intervention by the Arab Monetary Fund, based in Abu Dhabi, some insiders see the possibility of another international financing freeze-up similar to, and potentially as severe as last year’s.

What we do know for certain, however, is that deft criminality, that is risk taking for the benefit of bank executives  that is mindlessly guaranteed by disinterested third parties, has made commercial banking far less stable and resilient than it once was.