Global markets have been enjoying a fairly steady upward climb ever since March. Last week, however, that steadiness was challenged by a shocking announcement from Dubai World. On the eve of Thanksgiving, Dubai’s state-owned investment company dropped a debt bomb on markets, stating that it needed to postpone debt repayment on $59 billion in loans. On Tuesday, we learned that Dubai World is in negotiations to restructure $26 billion.
The news shows that reverberations from the global financial crisis are not over. “It is an aftershock,” says Uri Landesman, head of global growth at ING Investment Management. “... The global financial meltdown was causative of what’s happening right now ... but I believe that this is largely idiosyncratic.”
Andy Busch, a global foreign exchange strategist and public policy strategist for BMO Capital Markets, says he too thinks the contagion is contained for now. “I don’t think it’s going to lead to anything more for the region than what we’ve had right now. I don’t see it permeating out,” he says.
Landesman says that while Dubai World is not a meaningless debt issuer, the company’s debt is minimal when examined across the global financial system. U.S. bank exposure from banks like Citigroup
Sizing up investors’ reaction
In the broader context, Busch says there was great concern that the Dubai World incident could have triggered a domino effect, with money being pulled out of emerging markets. “Fortunately, that hasn’t happened yet,” he says.
Busch says the key is the linkage with commercial real estate. “The shock wave was as big as it was, not because it’s Dubai, not because it’s the Middle East, not because it’s emerging markets, but because it’s emerging markets coupled with commercial real estate, which Fed Chief Ben Bernanke and other members of the Federal Reserve have been warning about for probably six months,” he says. “That’s why I think things got very interesting with this development.”
Landesman says much of investors’ panic can be pinned on Dubai World’s poor handling of the matter. He says he thinks the company should have held debt-restructuring conversations prior to the company-issued statement. Had that occurred, he says, he doesn’t think investors’ reactions would have been as extreme.
“I think the statement that they issued was shocking,” Landesman says. “The fact that the debt holders had not been given any pre-indication was ... it’s just not done the way they did it. [If it were done right,] you come out with something everyone knows is negative, but not nearly as negative as essentially threatening a default.”
Picking up the pieces
Dubai sealed its fate during the last boom, when it overdosed on credit to fund a real estate bubble ranging from man-made ski slopes to towering skyscrapers. Now it’s feeling the hangover, and it’s only beginning to deal with the notion of “too big too fail.”
The United Arab Emirates and Abu Dhabi have said they will support their financial institutions; however, they did not explicitly state they would stand behind Dubai World. “I think that’s important if we extrapolate this back to the United States, because that really underscores that they don’t have a ‘too big to fail’ policy,” Busch says. “That should put everyone on alert that, if they think that just because they’re associated with this region or the UAE that we’re going to stand behind it, you are mistaken.”
Future debt bombs?
Though the effects of Dubai World’s actions remain contained, there could still be more isolated debt bombs, Busch warns. He points to Mexico, which was recently downgraded by Fitch Ratings, as a possible candidate. “They’re on the radar screen, though they’ve stabilized a bit since the downgrade,” he says, adding that both Greece and the Baltic states also have serious issues. “Those countries are clearly going to continue to need support from the ECB [European Central Bank] or other sources to get through the problems they’re experiencing right now.”
Landesman says isolated pockets of asset bubbles -- in real estate or otherwise -- aren’t impossible. However, he says he doesn’t think such things would have the same impact that Dubai World did, given the magnitude of building and leverage that Dubai World took on, coupled with its handling of the announcement of the debt deferral. “I don’t want to suggest that there aren’t commercial real estate issues in other places of the world -- there are, but they aren’t as leveraged as Dubai World was,” Landesman says. “The supply demand situations there are more reasonable, if not favorable.”
Landesman says the Dubai fallout doesn’t change how he thinks about emerging markets, though it does show how quickly people panic. “That tells me even the bulls have not dug in their heels,” he says. “There’s a low level of conviction in this recovery, and so that means that the market is susceptible to pretty big swings every time there’s some bad news out there. But it also presents buying opportunities.”
In light of the skittishness of market participants and the possibility of future events akin to this one, Landesman advises investors to maintain a bias toward higher-quality names that are as immune as possible to idiosyncratic risk.
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