Thursday, December 17, 2009

Dubaican on Debt, Diversification, Denninger, and Transparency"

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so"
-Mark Twain

Attended the Bloomberg Conference on Debt, Danger, and Diversification in the GCC.

I feel like the recent news and crisis as well as some of the topics discussed yesterday warranted a post….

Debt is good? Speaking from personal experience I think I can safely say I would never say debt is good.

Debt to the extent that it is serviceable across a wide range of possible economic outcomes is good.(actually I don’t even like the choice of the word good, I’d go with a ‘has a place’) Of course determining what level of debt falls into this broad definition is no easy task. What one model shows as serviceable another may find unfeasible depending on your assumptions, hence, the desire for a definition that allows for a broad range of economic outcomes. While it is difficult to determine what level of debt is good/manageable/marginally boosting return on equity without in anyway jeopordizing the existence of that equity stake, it is not difficult to identify a level of debt that is malicious, predatory, paralyzing, or potentially cripiling. For the individual too much debt leads to losing control of your own life. The corporations problem is less severe as all that happens is it gets transferred to creditors or liquidated. Debt is good or even great until it is not, and then it can be disastrous. So, while some level of debt may be good or even great, no debt is always good provided that you know what to do with your savings.

Dubai fails to grasp the concept of transparency? Will they Change? This came up a times and the panel pretty much was of the view that they are progressing down a road towards more transparency. I don’t disagree, but I think labeling transparency a Dubai problem is either a narrow minded way of looking at transparency or just plain wrong.

In my opinion, the Dubai dilemma is at the end of the day a simple story. It is a reflection of the flaws of the financial system which I think were evident to many observers. From the moment I got here, I took the view that Dubai was the world’s first sovereign hedge fund. Dubai, or as Moody’s dubbed it, Dubai Inc., was set up as a complex limited liability company. Anyone with a legal background or any experience looking at convoluted structures understands that there are only two reasons to adopt such a model. The first being to limit liability in case anything goes wrong. The second reason, which is not as obvious, but clearly was the main driver of such structures over the past decade, is to maximize leverage. By creating layered holding company, you can embed leverage at many different levels. To succeed at such a model you need to limit transparency, in fact, you actually need to get pretty good at being opaque. Those questioning Dubai’s transparency should understand that it was most likely by design, and not the result of some fatal regional flaw. Now that transparency will serve them well, they will provide a high level of it.

To put Dubai on the map outlandish feats needed to be accomplished. In many instances, what many thought was only imaginable was turned into reality in a span of a few years. Such a model once it gets going isn’t designed to naturally cool off. Someone or something has to intervene to slow it down or grind it to a halt. Dubai’s only problem is that some people just don’t want to let them invoke their limited liability shield.

Diversification- There was a lot of talk about the failures of diversification. I blogged about this at the peak of Middle East Mania in June of 2008(LandMark Properties, Rich Foreigners, and American Know How). My views on the topic have not changed. The region needs to employ better financial planners.

The average Arab in the gulf doesn’t wake up in the morning wanting to buy a gulf course in Scotland or a ski resort in Colorado. Typically, what happens is an ex-banker(consultant or lawyer works too) who is now in the employ of a government related investment entity in the Gulf generates such an idea. It most likely comes from his ex- colleagues at certain investment banks or consulting firms that are advising the western owner of such an asset. Furthermore, these ex bankers have usually gone skiing at said resort or played a few rounds on the famous course that is up for sale. Thus, they have no problem selling themselves and subsequently their bosses on the deal. Furthermore, the ex-banker has been hired to do deals, so it should be no surprise that he gravitates to what he knows and also what his former colleagues in NYC and London are recommending. So, when you criticize the gulf for diversification, you are in effect criticzing the hiring decisions they have made. Now, this doesn’t mean all bankers who worked in the west are likely to always lose you money, but it does mean that if someone is just showing you a non-stop pipeline of deals in the same sector that do nothing but lose you money, you should probably consider finding someone a little more discerning.

Debt markets and Politics-
The fact that it costs more for GCC nations to borrow than most developed nations is in my opinion quite ironic. Their balance sheets are better, they posses relatively miniscule populations, and they are resource rich. The only reason to pay a spread is that you believe the political situation will turn on you or that the governments and people in the region will be fleeced consistently across multiple economic cycles by buying high and selling low and thus ultimately transferring away accumulated oil wealth. If Naomi Klein or John Perkins was commenting on this I am sure they would take favor the latter. Banks lending money at completely ludicrous terms to people or governments in the region, they are either incompetent or following an agenda. As far as incompetence, I think that has more to do with the compensation structure at banks being flawed and thus incentivizing excessive risk taking. As for the agenda view, it’s not very complicated. Take someone that is resource rich and get them to borrow against their resources to buy overpriced and unproductive assets from you. Then pressure them to borrow even more money to repay the bad loans you might still be carrying on your books or to refinance at higher rates under the guise of systemic risk, thus effectively gaining more control over the resources in the ground. Use a massaged/engineered crisis to further your own regional political agenda by providing debt relief in exchange for strategic concessions.(think iran)

Denninger’s Ridiculous Rant-

Karl Denninger of the market ticker is someone I have read for quite a while. He can at times come off as a crazy conspiracy nut, but he usually does offer some very insightful commentary. When Dubai World announced that they were seeking at a stand- still he was quite complementary of the fact that there was no bail out. However, when the nakheel debt was paid he reversed course. I have no problem with that. What does bother me though is that he turned it into an opportunity to launch a political and cultural attack on the UAE and the region. Zero hedge has not been much better, but at least i understand where they are coming from.

“Let's face the facts about Dubai - you've run an effective slave labor camp over there for the last decade - a practice that supposedly disappeared worldwide in the 1800s.
But in point of fact, effective human trafficking and slavery have not ended. It was, however, the necessary condition for "Dubai World" and its similar adjuncts to be a viable economic entity, given that Dubai has zippo for natural resources (unless you count the raw material for high-quality glass to be a natural resource, although it is not exactly in short supply - or expensive) and was entirely reliant on conspicuous consumption of oil revenue - which incidentally also seems to all belong to what amounts to absolute monarchies and those who they have enabled - for its continued "prosperity."
We are here today to reassure investors, financial and trade creditors, employees, and our citizens that our government will act at all times in accordance with market principles and internationally accepted business practices. Dubai is, and will continue to be, a strong and vibrant global financial center. Our best days are yet to come.
Do those "best days" continue to include dumping raw sewage - complete with the condoms used by your Islamic friends who use Dubai as a place where they can ignore Islamic Law (provided you're one of the privileged rich) a few hundred yards from your "pristine" beaches?
Go have another hit off your hookah Sheikh. Your vision of a "global financial center" for those with too much money and too few brain cells will eventually be reclaimed by the desert, as it should be.
I continue to believe that the "infidels" will get hosed, and as noted above, there are plenty of weasel-words in your "statement" to keep anyone from claiming you lied through you teeth when the unilateral imposition of haircuts - against all but UAE-aligned interests, of course - begin.”-Market Ticker, Karl Denninger

To be fair. This is not new for Karl. When it comes to politics and foreign policy he often appears to be as ignorant as the people he so astutely criticizes on economic and financial market issues. I challenge Karl to compare the living conditions and treatment of construction workers in Dubai to those of Mexicans working in slaughterhouses or food processing plants in the US. I also challenge him to defend the treatment these people get from immigration while the massive corporations that knowingly employ, and in fact depend on cheap and unlikely to be able to defend themselves labor force, get away without even a slap on the wrist. As for his concerns that the UAE will seek to make local creditors whole before foreign ones; is he being serious? Check the language of most of the stimulus legislation that was passed this year? If you don’t see favoritism in there you are blind. Ask the single mother’s in the US that are working at a fast food chain what the eligibility requirements are for the earned income tax credit or a whole host of other tax credits. I once had a Mexican-American client in a tax clinic who was stripped of her tax credit because her husband was not a citizen and did not have a valid social security card, despite the fact that she was legal. And isn’t that how it should be? If you are a true believer in government economic support, shouldn’t the subsidies or assistance go to those firms employing people on the ground whose entire business is domiciled in the state first, or should they go to MNC’s that have contracts everywhere on planet earth?

Anyway, bottom line is Karl is criticizing the Gulf and UAE for stuff that exists in his own backyard. He just seems blinded by the fact that it is concealed in thousands of pages of legislation or buried by giant conglomerates.

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