Good Bye Dubai

It seems yet another multibillion dollar bubble-enterprise has popped. The tiny but rich little city state of Dubai has blown its wad. This week they announced that they cannot make their loan payments. They need to postpone them for another six months.

Dubai’s early claim to fame was she pumps a lot of oil: around 240,000 barrels a day. Then they decided to diversify into tourism. They hired a group of high powered western MBAs, put together a great business plan and gave birth to a spectacular modern city, an architect’s dream come true.

But there’s a catch. They borrowed the money to build their Oz-city. Let’s calculate Dubai’s gross income if oil sells at $100 per barrel; then we’ll re-calculate at $50 a barrel. I apologize for this painstakingly obvious exercise, but I’m sure you see the point. Dubai’s most important source of income is totally dependent on the price of crude oil, which can rise and fall dramatically. So, when the government of Dubai borrowed the $59 billion to finance their dream city, the lenders would have known that their ability to repay those billions would depend on the price of crude.

But, it’s not that simple. Oil is a depleting asset. One day Dubai will run out. [Current estimates give them about 20 years.] Dubai’s ability to repay its debt is tied to fluctuations in crude oil prices and then they will run out. So, when calculating how much money they should lend this ambitious little city, the banks know all this. What bank on earth would ever lend Dubai so much money that she would be unable to pay the money back?

Maybe the bankers were in dream land too. Maybe they had seen the 1989 movie Field of Dreams and believed the slogan: “build it and he will come.” In Field of Dreams, some entrepreneur built a baseball diamond in the middle of a corn field. And, sure enough, by the end of the movie, there were people playing baseball on it. It’s the Las Vegas story: they built a city in the middle of the Nevada desert, and sure enough, people came. Maybe that’s what Dubai’s lenders were thinking. But last week’s neo-bankruptcy puts that dream in doubt.

We can’t blame the ambitious leaders of Dubai for going for broke. They took a mega-risk, in hopes that their little desert nation could emerge into a modern economy. And it looks like they will lose. It’s the bankers that worry me.

All an honest banker could ever have expected to make on the Dubai Dream Field loans was interest on their money. Why would they make such long shot loans? Our guess is there was something more in this deal than boring bank real estate financing. There was something sexy, some sizzle, something not cut from a conservative banker’s cloth. The Dubai deal smacks of some secret, yet unspoken. In the mean time, the Dubai default shock ripples around the world’s banking system and the world’s financial markets. It’s not a huge default. American billionaires Bill Gates and Warren Buffet were once worth more than this whole Dubai default. No doubt the world’s banking system will weather this little desert storm.

Now it seems it would have been better for the citizens of Dubai if their leaders had had more conservative business plans. And it would have been better for all of us if world bankers had been less aggressive. What about you?

Are you a high roller? Are you betting on a long shot high roller’s dream? After seeing what happened to the stock market in 2008, are you still over-exposed? In 2001-2 the stock markets dropped about 45%. In 2008 it happened again. The stock market has become a high roller’s game. In 2008 corporate America came undone. In 2008-09 world banking came undone. And the Dubai default is showing us that we still live in risky times because of yesterday’s high roller bankers. Is it time to become conservative again? Is it time to quietly re-think your personal financial plan and make adjustments for the high risk times we live in? It seems we can’t trust big banks or big corporations to provide a financially stable world. We have to provide our own financial stability. It’s time to become more conservative in our personal finances.

Ken Norquay, CMT
Financial Philosopher.