Yesterday, the government of Dubai announced that it was selling $20 billion in government backed bonds to the UAE central bank. This transaction amounts to the cosmopolitan, commercial and hence more financially vulnerable Statelet of Dubai being bailed out by its oil rich, more conservative neighbor Abu Dhabi. With both its stockmarket and property values falling over 50% in the last few months, Dubai desperately needed this bailout. But this is no silver bullet.
The Economist once compared Dubai’s property boom to the Florida housing boom of the 1930’s. Back then, almost overnight, Florida became a hub for speculators, property developers and all others seeking more rewarding opportunities. When the bust came, it hit hard and again, almost overnight, Florida became a ghostly place full of half finished construction projects. Similarly, Dubai has appeared from the desert as a world famous metropolis in less than 30 years. Now, the global financial crisis threatens even this bastion of growth and opportunity.
On news of the bailout, Dubai’s stockmarket jumped 8% and newspapers were already proclaiming that Dubai’s future had been secured. This euphoria may be short lived. The $20B does help Dubai’s government meet its short term obligations and eliminate the possibility of a cataclysmic default. But investor confidence also needs to return in Dubai’s banks. Dubai lacks any mechanism to deal with a bank failure. Officially, all deposits are guaranteed by the government but the UAE has no federal body or established mechanism to deal with a bank run. One bank failure could lead to a rapid crisis of confidence prompting bank runs on other banks…leading to a downward spiral similar to the bank runs in the US and UK. Of course that could never happen in Dubai. Why? Conventional wisdom holds that the UAE would rescue any bank that came anywhere close to failure. Last month, Abu Dhabi injected $4B into its own banks. However, we’d all do well to remember that the inability to imagine the impossible precipitated this crisis in the first place. And Dubai is just beginning to feel the consequences.
And that’s jus’ the tip.
