The Dubai World situation, as it stands now

On Wednesday, Dubai government-owned conglomerate Dubai World announced it intends to ask creditors to postpone maturities on Dubai World’s debt until at least May 30, 2010.  The heavily debt-laden company intends to use the time to restructure itself.

In the grand scheme of things, where the world financial crisis has already seen trillions of dollars of value erased from global banks’ balance sheets, Dubai World is not much more than a drop in the bucket.  No one seems to know exactly how much the company owes to others, but the largest estimates remain below $100 billion (though not by much).

Why creditors should be worried

There are several disturbing aspects to Dubai World for its creditors:

1.  The announcement comes after repeated assertions by Dubai that the situation was completely under control.  Recently, for example, the government has consistently responded to enquiries about a $3.5 billion sukuk of Dubai World property subsidiary Nakheel that matures in the middle of next month by saying that it would be paid in full when it came due.

2.  The announcement coincided with the start of Eid al-Ahda (a religious holiday commemorating Abraham’s willingness to sacrifice his son Isaac) and the beginning of the UAE national day celebrations, so that no further information will be available for several days.  Whether Dubai intended this or not, it employed a trick often used by poorly-managed, troubled companies, of announcing information just before a weekend or holiday, in order to avoid having to elaborate–and in hopes of “burying” the press story so that no one notices.

3.  Press reports suggest Dubai made the Wednesday announcement before consulting creditors.  If so, that would be most peculiar.  And no banks have come forward that I’m aware of to say everything’s basically ok.

4.   As other financial problems involving sharia-compliant debt over the past year or so have illustrated, there are no established conventions governing their status in restructuring or liquidation.

5.  Ambiguity also extends to bank lending in the Middle East, much of which appears to have been done on a “reputational” basis–that is, because of the borrower’s perceived status or wealth–rather than after careful study of pertinent financial documents.

6.  In addition, in cases of monarchy like Dubai, the line between public money and private money is sometimes blurred.

7.  It’s also unclear how much financial support the United Arab Emirates, the federation of which Dubai is a member, will provide for Dubai overall, and to Dubai World in particular.

What should be worrying the stock markets

Emerging markets contagion?–not so much, especially with oil prices above $70 a barrel.

Serious problems in developed stock markets?  Maybe if this were happening a year ago, but I think that markets will properly size the Dubai problem (i.e., understand it’s small) in short order.

Worries about banks with exposure to Dubai?  Maybe.  For HSBC and Standard Chartered, Dubai exposure appears to be small.  Could Dubai lead to general sukuk fears–and thus to the assumption that any bank with sukuk exposure is a risk?  Could happen, but if so I think this would present a buying opportunity.

Downward pressure on stocks?  Yes, but not for the reasons you might be thinking of.  Big investors in Dubai-related sukuks may find themselves in worsened financial straits if money is not repaid on time–as it appears now it won’t be.  They may have other obligations they can’t now meet without selling other holdings.

Monday’s trading will be more revealing about how much the market’s psyche has been damaged by the Dubai World announcement.  My guess is that it won’t be a particularly big deal–but then again, I’m a growth investor, that is, an inveterate optimist.

Thursday and Friday aren’t telling, since Wall Street was closed for Thanksgiving on Thursday and worked with reduced staffs for Friday’s abbreviated trading.  Even looking at Friday, though, the US market sold off initially, bounced back during the day and sold off again–as one would have expected–before the close.  Short-term traders understandably haven’t wanted to hold net long positions over the weekend.  However, selling didn’t approach the early-day lows, which is a positive sign, to me anyway.  I’d imagined that the market might breach them just before the close and the day at new lows.  That would imply heavier selling on Monday.

See also my update of December 1st.