What to make of Dubai's debt woes

The Persian Gulf feels the fallout from the real-estate bubble.

By Anthony Mirhaydari Nov 27, 2009 2:12PM

MirhaydariGlobal financial markets were roiled after Dubai asked banks to allow its investment vehicle Dubai World to suspend for six months payments on debt of $59 billion. This comes as big bets on Persian Gulf real estate sour.

 

The first concern is a $3.5 billion payment on Sukuk (Islamic bond) from Dubai World's Nakheel unit due December 12 -- creditors may not accept a restructuring and credit rating agencies believe the move may quality as a technical default.

 

This puts at risk up to $80 billion in debt linked to the emirate and may very well result in the largest country debt default since Argentina in 2002. It also highlights concerns over the ability of governments to service their rapidly rising debt loads. Those on the hot seat include Greece and Japan. I wrote about these concerns in a previous post.

 

As traders return from the Thanksgiving holiday, stocks and commodities are weakening, risky credit is selling off, and the dollar and U.S. Treasury debt are rising as investors seek safe havens.

 

This behavior, tied to the increased prevalence of dollar-funded carry trades, is discussed in my column on the dollar (The dollar's down decade). The CBOE Volatility Index or "Fear Index" was up 26.5% at one point -- a jump of a magnitude that hasn't been seen since the depths of last fall credit crisis. According to Tim Backshall at Credit Derivatives Research credit markets are having their worst day since March 5.

 

Nikkei

 

European banks are believed to have the most exposure to Dubai's problems. But Asia, specifically Japan, is showing the most weakness given its precarious public debt position. In Friday trading, Tokyo's Nikkei stock index has moved down to its July low. If U.S. stocks were to follow, the Dow Industrials would be looking at a decline of 22%.

 

So is this the beginning of a new crisis? The team at Capital Economics in London doesn't believe it is: "Dubai's current problems are a long overdue consequence of the bursting of the global property bubble rather than the start of a new financial crisis. Nonetheless, they are a timely reminder that the legacy of past excesses in heavily-indebted economies will linger for many years to come."

 

My positions

 

Given today's light trading, I'm including to withhold final judgment on the move until next week. Dubai's debt default could, however, provide the catalyst needed to pull stocks lower given lackluster breadth and volume trends over the past few weeks. My portfolio at Wall Street Survivor remains heavily short and is up 27% this month compared to the 7% rise in the S&P 500.

 

Disclosure: The author does not own or control a position in any of the funds or companies mentioned.

 

Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.

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