Wednesday, December 9, 2009

Dubai (Again? Still?)

[7:05am ET] Bill Cara's Morning Call

By Bill Cara | 9 December 2009

Within hours of the November 25 Dubai debt crisis reports, major U.S. and European banks issued a flood of analyst reports and parade of talking heads running to Tout TV opining that global capital markets would take any losses in stride. Business as usual they said. They lied. Moreover this gang I call Humungous Bank & Broker (HB&B) lied to serve and protect their own interests.

Since that time, the main DFM index of Dubai has crashed -26.8%, which is a Bear market in 13 trading sessions, the equivalent of the dreaded collapse of the U.S. equity market on Black Monday October 19, 1987. Moreover, Dubai's neighboring emirate Abu Dhabi has experienced a plunge of -14.9%. Abu Dhabi, which has come to the rescue of Dubai recently as their financial interests are interwoven, has its own problems. Unlike Dubai which doesn't have oil, Abu Dhabi is an oil Kingdom— which is the source of another bind: the Kingdom needs $85 oil, not $70 oil. Ergo: Goldman Sachs' dubious recent $85 oil 'forecast'.

Are these market problems getting resolved? The answer is a resounding no! Today the Dubai index dropped -6.5%, which is impressive given that the maximum permitted decline in a single day in any individual stock is -10%. Emaar Properties, a giant developer there, crashed -9.86% today and -9.84% yesterday. At the core of the problem is Nakheel Properties, the largest property developer in the world, the real estate arm of investment company Dubai World, which in turn invests for the Dubai government, and is controlled by majority owner and ruler of Dubai, Sheikh Mohammed bin Rashid Al Maktoum.

Nakheel Properties

Dubai World

Mohammed bin Rashid Al Maktoum

Here is the problem: Nakheel is essential to Dubai World as the aggressive expansion was financed by debts tied to Nakheel. But the debts of Dubai World cannot be repaid because Nakheel cannot pay. Dubai World has 60% of the total debt of Dubai. If Dubai World cannot pay, the credit agencies drop their debt rating, which in turn triggers accelerated payment requirements, often by immediate notice.

The bottom line is that Nakheel's problem leads quickly to the bankruptcy of Dubai, which in turn will lead quickly to the bankruptcy or forced asset sales of many banks and investment companies around the world. A crisis like this happens in credit markets at least once every 10 or 20 years. The reason is simple. Regulators permit general assignment rather than requiring all capital projects to be financed on their own merits, with a debt strictly limited to its project.

This issue is at the core of my argument that HB&B should not be allowed to exist, but be forced to restructure into separate entities, those that sell risk on the one side and those that buy risk on the other. Each has different financial objectives [[and uses a different financial calculus: normxxx]], a different culture. Each needs to be regulated separately and distinctly.

When insiders are compensated much more for 'making' money than protecting it [[or generating it as the result of productive efforts: normxxx]], then it is abundantly clear that risk management is given lip service as compared to 'opportunity' management. Whenever the debt market cycle reaches a state of crisis, there is a focus by law makers on bankruptcy law. Already a patchwork quilt, bankruptcy law is the result of vested interests that have bought and paid for the votes of law makers. There are enough books and papers written on this subject to fill a library, but regrettably nothing is going to change for the reasons I have given here.

Let's come full circle in this discussion so that the little guy can appreciate what I have been saying in this blog since I started it almost six years ago. If you have the money, and some 'dream merchant' has the story, you are only going to live your dream if you come to appreciate that in every transaction someone is buying risk and someone is selling risk. As a buyer, then, risk management is your Job #1.

This is why I buy quality and value. Value means buying low— lower than others— the ones who hold more risk than you. Nakheel Properties and Dubai World are said to be in trouble. No, I think the buyers of their assets and debts are in trouble. Moreover, the second and third derivative buyers of their assets and debts are also in trouble. Like Royal Bank of Scotland (RBS) for instance, and the owners of RBS, like the UK taxpayer.

Financial leverage works both ways; creating wealth quickly, destroying it even more quickly. Every debt crisis proves it. It's why there is the expression, Buyer Beware. Pity, too few people listen.

Elsewhere in the market today, the chickens have come home to roost in Greece. The European Union monetary authorities have long attempted to have Greece play by the rules. Now the sovereign debts of Greece have been downgraded from A— to BBB. As risk is elevated, financial assets are being re-rated all the way down the line. Today so far, the Athens Stock Exchange Composite Index is down -2.37% at this point. National Bank (-5.2%), Alpha Bank (-4.0%), Eurobank EFG (-4.4%), Agricultural Bank (-2.3%), and Piraeus Bank (-4.9%) are leading the market down. Elsewhere in Europe, HB&B is trying desperately to get its act together, rallying the market about +1% in the past couple hours, following an earlier sell-off that was consistent (-0.7% to -1.7%) with most of the Asia-Pacific markets, where the Financials were also leaders to the downside.

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