Dubai Debt Story More Like Bear Stearns Less Like Lehman Brothers

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The task of today’s Daily Reckoning is to show that the Dubai debt story is more like Bear Stearns and less like Lehman Brothers. A second task is to show that the news from Dubai could be the catalyst for fund managers and traders to take profits on all of their 2009 winners. This could lead to steep falls in emerging market stocks, including Australia.

But first things first. Dubai World is not nearly large, leveraged, or systemically important as either Bear Stearns or Lehman Brothers when both those firms failed. For those reasons, it’s unlikely that the failure of Dubai World (and we’re not saying it will fail) would, by itself, cause a global deleveraging.

Dubai World has $59 billion in debt. That makes up the majority of the $80 billion in debt of Dubai itself. According to Reuters, international banks are exposed to $12 billion in debt. Incidentally, the Commonwealth Bank of Australia said it has exposure to Dubai but doesn’t expect to make a loss.

There is some risk to CBA, no doubt, just as there is risk Dubai’s other lenders. But it’s nothing like the risk posed to the entire financial industry by Bear Stearns and Lehman Brothers. For starters, the Bear Stearns High-Grade Structured Credit, and High-Grade Structured Credit Strategies Enhanced Leverage Fund were both massively leveraged. The first fund began with $600 million in assets but quickly borrowed on that to increase its asset portfolio to over $6 billion.

The trouble with that is Bear geared up to buy collateralised debt obligations (CDOs). It may not have known it at the time, but the CDO quality sucked. The CDOs were chock-full of subprime mortgages. In 2006 alone, $503 billion worth of CDOs were issued. It was a $2 trillion market by 2008. A fall in the value of Bear’s assets – a big chunk of which were CDOs – was enough to wipe it out.

Dubai World is likely to be backstopped – at some point – by Abu Dhabi. And although we’re sure it has its fair sure of property assets falling in value, Dubai World owns assets all over the world which it can sell. And, importantly, Dubai world is probably not a counterparty to many other financial arrangements in the same way Lehman Brothers was, at least as far as we know.

But still. You wouldn’t be alone if you had an odd sense of déjà vu this morning. We’d say the Dubai affair is more like Bear and less like Lehman because it’s a warning. Dubai may not be as systemically important as Lehman, but it is a reminder to all the world’s investors that global financial markets remain highly leveraged. And we know what can happen next.

There are other, much bigger, and much more leveraged markets that pose far bigger risks to the global economy. For example, in the U.S., there is over $3.4 trillion in debt backed by commercial real estate owned by U.S. banks. A presentation by a Federal Reserve analyst in late September suggests that the U.S. banks have failed to set aside adequate capital to cover losses in commercial real estate. It’s safe to say the U.S. banking system – and by extension Australia’s – would not survive another real estate collapse without major casualties.

And that is just one debt bubble. The other large debt bubbles are in China – which hedge fund manager Jim Chanos calls “Dubai times 1,000” and in government debt. The China bubble and the U.S. Treasury bond bubble ARE systemically important. And that’s what we should be worried about now.

But what’s happening in the short-term is not quite what you’d expect. Emerging market stocks are selling off. In fact, don’t be surprised if Dubai is just the excuse fund managers use to take profits on a lot of 2009 positions. It will make this year’s performance statistics look great by crystallising a profit now. And who can blame a manager for being cautious?

Already the cost of insuring sovereign debt from default – as measured by credit default swap rates – is rising. Yes, it does seem a bit absurd that debt crisis in emerging markets is driving investors into U.S. Treasury debt. But that’s what’s happening in the short-term. You may get a dollar rally and lower short-term U.S.rates.

How will Australian share markets fair, then? Good question…

It depends on how the rest of the world views Australia. If it’s viewed as essentially an emerging-market, commodity-related, high-yield risk asset play, stocks are going to get sold off. The Aussie dollar will give some ground against the greenback. And the market will wait to see how exposed Aussie banks are to any of the bourgeoning debt bubbles.

The bigger issue is the exposure of the Australian economy to the Chinese economy. According to the government and the media, that is the difference maker for the Aussie economy. It’s what guarantees future surpluses, growth, and prosperity. But if the Aussie economy is hitched to China on the upside, surely it’s hitched to China on the downside too.

Not that any of this potentially catastrophic news should stop Aussie houses from getting bigger or more expensive!

CommSec released a report yesterday showing Aussie houses are now the biggest in the world. The floor area of the average Aussie home is now 215 square metres. That’s a ten percent increase in the last ten years. Maybe Australians just need more living room!

The world’s growth is built on a debt bubble. The bubble is popping. Dubai is a tiny bubble by comparison. The bigger pops are coming.

Here’s a question. What if there was a serious debate about the integrity and objectivity of scientists who are pushing climate change, and the Australian media decided to bury the story? You would hardly know a big debate is raging about how honest the scientific establishment has been with its…er…science in support of anthropogenic global warming.

If you’re just catching up to the story, try this.

In the meantime, we returned from New Zealand to find the political establishment in an uproar. The Labor party and the media are having a field day at the disarray in the Liberal party over its climate change policy. It’s all quite entertaining.

But it’s also all quite a huge charade. How can you have a serious debate about an emissions trading scheme and carbon dioxide emissions in Australia without acknowledging the fact that a major global debate is now swirling about the science itself. Does it make any sense at all to make policy when the problem itself is in dispute?

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. re climate change data, you are referring to the email leaks showing the Climate Research Unit has been fudging the stats on global warming, and that the original data was dumped in the 80’s.. so we will never know. so much for science.
    in my view it doesnt necesarily invalidate what is happening in the real climate world, or what we are doing to it, but it does raise serious issues about the clowns from all walks of like (ye gads, not the scientists, surely?) who are embedded in the rottenness of the system.
    it would be a whole lot easier and better all round if there was more honesty and (trust but verify), transparency.
    thanks for brining it up.

    Reply
  2. Oh Dan; A little scandal isn’t going to stop useless bureaucrats from taxing us all the way to financial ruin.

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  3. It’s an important point and worth discussing, but the supposed conspiracy doesn’t hold water when examined in the light of the facts. None of the emails indicate that there is a major ring of scientists actively twisting data as part of a global warming hoax. Certainly a few key scientists at the CRU have not acted in faith and have undermined the essence of science..there should be a penalty for this outrage. But it reads more like a cherry picked selection of a bad day at the office from a bunch of scientists eagerly possessive of their work.

    This doesn’t change the thousands of other scientists and investigators who have been documenting other evidence from other places in the world for decades. It doesn’t reverse the global climate indicators such as permafrost melting, reduction in glacier ice, rising sea levels (a 5cm rise has already been recorded) and seasonal variation observed in plants and animal behaviour adjusting to a changing climate.

    http://arstechnica.com/science/news/2009/11/five-things-you-should-know-about-climate-change.ars

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  4. Aussies need bigger houses so that their egos will fit in too, that’s why :-)

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  5. Yeah who on earth would be so naive as to think that politicians would conspire to tax us. Its not like they need the money to expand control or cover a debt derivative implosion or anything.

    Lachlan Scanlan
    December 1, 2009
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  6. beyondtool says a 5cm. rise in sea level has been observed. Where? When? Over what period of time? Observed by whom? Using what technique to derive measurements? Is their raw data available for perusal?

    The city I live in is located in the estuary of a major river. Much of it located on islands in the delta. All the islands as well as the flood plain mainland portions are protected from the sea storm surge and river flood by dikes. If there were any sea level rise going on in this part of the world the half million of us exposed to the consequent risk would be screaming our heads off.(The other half million live well above sea level) The greenies around here are indeed screaming about sea level rise but not in reference to our shoreline. They only talk about places like Tuvalu where no one around here has ever been.

    If the Pacific Ocean is swallowing up islands in the middle of the ocean why is the West coast of North America untouched. Most of Sea Island where our international airport is located is well below sea level on a high tide so it’s even lower in the ocean than Tuvalu and such and yet we see no increase in sea level change here other than the normal geophysical change that’s been taking place for thousands of years.

    northernguy
    December 1, 2009
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  7. “How can you have a serious debate about an emissions trading scheme and carbon dioxide emissions in Australia without acknowledging the fact that a major global debate is now swirling about the science itself.”

    …because (you fool!) it is about the preponderance of evidence, not every little detail. The day scientists stop debating is the day we’ll all be dead.

    Global warming science aside, if you can’t see that the current trajectory of the world economy (automobile and airline based transportation, environmentally damaging frivolous consumption, urban sprawl and all the rest) is putting us (the world’s most successful species in history), our societies and our very survival at risk, you really are a fool.

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  8. …apparently over the last 50 years, the dutch people on average have grown 4 inches taller than they ought to be, which would indicate that a consequent rise in sea levels is part of a natural evolutionary phenomena…

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  9. Funny how everyone is an expert on climate change. Try this analogoy:

    Next time my doctor makes a diagnosis I’m going to demand to see the evidence, pick holes in it, question his logic and training, query the calibration of the measuring equipment , and if I can’t find any problems accuse him of being part of an conspiracy to sell me medicine I don’t need.

    Medicine is based on biological SCIENCE, and the sceptics are questioning science itself…

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  10. There are plenty of people who question their Doctors! If you are ever diagnosed with a serious condition it is quite common for people to suggest a second opinion, research their ailment on the web etc. There are also thousands of people who look for alternative therapies instead of letting the butchers cut out the bits they don’t like or prescribe us chemicals. What about Cancer? It’s far, far from understood… At the moment we cut it out, fry it with radiation or poison the body with chemicals to try and kill it off. If we understood it we would probably be able to prevent it. Maybe we should tax anything the scientific community has ever linked to causing cancer as a way of stopping cancer? No. That would be silly…. Or maybe we could have a CCRS (Cancer Causes Reduction Scheme)?

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  11. Richo,
    Most climate science is not rocket science. I am an engineer and I can easily comprehend most of the science and statistical assessments. The skeptics are not questioning science itself, that is a silly comment.

    They are questioning the junk science practiced by the IPCC and its small cadre of zealots. The IPCC clique does not follow the scientific method. Their predictions for the last decade are miles wrong, yet they refuse to even consider questioning or revising their hypothesis. Global warming alarmism is politics not science.

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  12. I am with you Graeme. As an engineer I am not questioning “science” but I do question the use of models and other tweaks the IPCC has been using to deliver the outcomes they want.

    I also question how we will save the planet by bringing in a new tax and then compensating heavy C02 emitters or by hiding the C02 underground and hoping it doesn’t ever leak out!

    Finally if scientific theories were not questioned we would still believe the earth was the centre of the solar system!

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  13. The Australian Media are letting us down, for sure. However that’s hardly news.

    One problem that the antrhopogenic global warming hypothesis has, is that (like the theory of evolution by random mutation) it’s not readily falsifiable. The proposed experiment controls no variables, attempts to vary only one (CO2) and only measures one result (average minimum temperature), and takes a generation to produce a result.

    It’s almost an insult to the planet to suggest they’ll find a simple correlation between temperature and CO2, and they’ve got about a 1 chance in 3 of simply guessing what the climate does in some period of time (up/down/same). Further, if they’re ultimately wrong, they won’t have any face left to save (it’ll be rotting in the cemetary). If they’re intermediately wrong, they can just postulate a new variable without abandoning the first. The kicker is that even if they’re ultimately right and the world warms up, they still won’t have been able to prove that CO2 emissions were in fact the cause of the warming, because they didn’t (couldn’t) control any other variables. It might easily have been the sun all along, but what’s to stop them claiming success for their hypothesis? Same thing goes if CO2 is reduced but the world doesn’t warm up – what’s to stop them claiming success for their hypothesis?

    CO2
    ————————————–
    | WorldTemp | Up | Down | Same |
    ————————————–
    | Up | Y | Y2 | Y2 |
    | Down | X | Y | X |
    | Same | Y3 | Y4 | Y3 |

    Y = “told you so”
    Y2 = “told you so – you were too late”
    Y3 = “told you so – it’s still going to happen”
    Y4 = “told you so – we did it!”
    X = “er, um, ah … well clearly CO2 isn’t the _only_ variable …”

    In other words, the hypothesis claims victory for 7 of 9 actual outcomes, with the only falsifying events being world cooling irrespective of CO2 reduction.

    It’s the perfect wheelbarrow to push a political agenda in, but let’s not mistake it for science.

    The real kicker that makes it all seem like conniving instead of simple mass delusion is the settling on the term “climate change” They won’t even popularly commit to global *warming*. In that case, they claim victory for their theory on all 9 outcomes.

    Oh no, the climate *changes*? Any historian will smack their forehead and say “well, duh”.

    David Bullock
    December 3, 2009
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  14. David

    You seem to miss the point. The Greenhouse Event has been popularly decribed as global warming, a popular and simplistic tag. The effect of greenhouse are intensification of all weather types – hotter hots, colder colds, wetter wets and drier drys if you like. Certainly being observed in historical patterns of flood events and drought. The reason the effect is so dangerous relates principally to the billions whose water supply is becoming marginal and food yields in an increasingly mono-agricultural scenario. It’s not principally, and never has been, about warming. Its the emerging (I would say strongly supported by data) emerging climatic variability that is testing a range of critical environmental, social and agricultural equilibria.

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  15. Let’s not forget the buzz term has changed from “global warming” to “climate change”….talk about hedging your bets. Now if we find the planet is actually cooling the IPCC and others will come back and say unless we cut CO2 emissions we will all freeze to death!

    Do I believe in climate change?..sure it happens every day. Will a new tax stop it?……of course not. Is man responsible for it?..no, never has been but perhaps our CO2 emissions do have an impact, however this has yet to be proven.

    I still think we are maybe focused on the wrong issue as I wrote a while back: http://www.shareswatch.com.au/blog/opinion/are-climate-change-and-global-warming-dangerous-distractions/

    Are C02 emissions really the biggest problem we have to deal with? Have we had any debate on that subject at all?

    Greg Atkinson
    December 3, 2009
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  16. Michael,
    Your quote “Its the emerging (I would say strongly supported by data) emerging climatic variability that is testing a range of critical environmental, social and agricultural equilibria.”
    Where is the data? Who produced it? Please let’s be factual rather than emotional in this debate about climate change. The proponents originally called it global warming and suggested millions were doomed by rising sea levels. When global warming was debunked, the proponents changed the terminolgy to climate change and suggest the evidence is hotter hots, wetter wets, drier drys, windier winds. Very difficult to prove and disprove such motherhood statements so the proponents can retain their scaremongering campaign and continue to agitate for a world tax. Factual evidence will win your argument. Please deliver or shut up.

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  17. Australia produces about 8,800 tonnes of Natural Uranium per year (of course 0.7% of this is the good stuff U235).

    According to sources – every tonne of Natural Uranium can (when enriched) provide 40,000,000 kWhr of power.

    In 2005 Australia generated 240 billion kwhr of electricity. That is 240,000,000,000 kWhr

    So doing the simple math:

    8,800 x 40,000,000 = 352,000,000,000 kWhr of juice this Uranium goes on to produce.

    So by my calculations 68% of our production represents our ENTIRE power output in electricity.

    So please explain to me why we send this on to some European snoozers who then go – Sacre Bleu!! Voila! Low carbon nuclear energy from Australia and then turn around wagging their fingers tut tutting us about our dirty economy. Incredible -we deserve what we get for falling for this scam.

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  18. Ryan

    “Global warming science aside, if you can’t see that the current trajectory of the world economy (automobile and airline based transportation, environmentally damaging frivolous consumption, urban sprawl and all the rest) is putting us (the world’s most successful species in history), our societies and our very survival at risk, you really are a fool”.

    Fair point. You only have to take an airline flight almost anywhere in the world and look out the window to see that most of the landscape has been sliced, diced and grated. I took a couple of flights in Borneo about ten years ago naively thinking I would see rolling carpets of forest – nup, squares and rectangles, palm oil plantations, forestry roads and rivers the color of chocolate.

    Reply

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