Abu Dhabi’s tentative bailout of Dubai …
The UAE’s central bank will apparently use $10 billion of its foreign exchange reserves to buy $10 billion of a (planned) $20 billion Dubai debt issue. That will provide Dubai with $10 billion in foreign exchange (Dubai gets the UAE’s dollar reserves in exchange for an IOU, the UAE gets a dollar-denominated claim on Dubai … ) to repay $10 billion of its external debt. Lex writes:
Dubai’s $10bn cash injection from the United Arab Emirates’ central bank has eased concerns about the struggling emirate’s ability to make good on $13bn in debt payments due by the end of this year. Just as important as the deal’s dollar figure, however, is the political message it sends. After weeks of uncertainty, Abu Dhabi, the Emirates’ oil-rich sugar daddy, has demonstrated its willingness to stand behind its poorer relation. … Strictly speaking, the UAE central bank’s purchase of $10bn of five-year Dubai bonds – part of $20bn in new bonds priced at 4 per cent interest – was agreed at the federal level. But at its core, the move amounts to a bail-out by proxy of Dubai by its wealthier neighbour, Abu Dhabi, which is the biggest contributor to the UAE’s federal budget thanks to a quirk of geography that left it holding 8 per cent of the world’s oil reserves.
I find it interesting that the financing for Dubai came from the Emirates (the confederation), not Adu Dhabi (the richest emirate). As Lex notes, it arguably is the same thing: Abu Dhabi’s oil ultimately backstops the federal government. But it nonetheless suggests:
a) Abu Dhabi – meaning the large investment funds of Abu Dhabi — itself may not be all that liquid. Abu Dhabi may be kind of like Harvard: very wealthy, but caught between ambitious plans to invest some of its resources at home (Harvard is planning a new science campus, Abu Dhabi is a lot wealthier and is planning a lot more … ), falling inflows, falling asset values and growing calls on its capital from various illiquid funds it has invested in.
B) Abu Dhabi doesn’t want to sell its existing foreign assets at distressed prices to finance Dubai. Tapping on the central banks existing liquid reserves is a way to avoid selling other assets …
Of course, financing Dubai through the central bank means that the quality of the assets on the Emirates central bank balance sheet will deteriorate. The central bank has traded $10 billion of liquid foreign assets for $10 billion of Dubai’s illiquid bonds. Dubaican notes that the coupon on the bonds looks well-below market, adding to their illiquidity. And, well, if other demands for liquidity materialize, Abu Dhabi could well have to meet them out of its own resources.
Sometime back I read a more-than-half-page spread in the ‘The Hindu’ about the Dubai construction sector bust which was causing a massive stream of fired Indian construction workers returning from there. The article contained a statement that Dubai was relying on Abu Dhabi for a bailout from the situation.
One distinction you’ve made is that using forex reserves help avoid selling other foreign assets at reduced prices. But, using forex reserves also helps exchange USD reserves for other items of value.
Apart from financing local fiscal deficits, bailing Dubai out, what are the chances that these changes indicate a shift away from USD denominated central bank reserves ?
Russia, China and Oil exporters like UAE are all exchanging their USD reserves for some *real* benefits. Russia is increasing political influence by lending its reserves out; China is securing its supply of commodities through that route; and the oil exporters are exchanging their reserves for domestic fiscal outlays.
I think this points out a major problem. There are four pillars of the international financial system, the United States, the EU, China, and the Middle East. In order to get through this crisis it’s necessary to avoid a collapse in any of these four regions since they are interconnected enough so that a collapse in one will ripple through the others.
Among these four areas, the Middle East is the one that is the least transparent and the most poorly understood. It’s also the one that has the least political coherence. If the US Treasury secretary wants to talk about Europe and China, there is a number that he can dial to talk to someone, but this isn’t the situation with the Middle East.
This may pose a problem because if necessary you can ask the US, Europe, or China to do or not to something, but there is no one in the Middle East that you can call.
@Twofish: You point out the stability of foreign regions as a neccessary condition for recovery. In that context very little attention has been paid to the state of the domestic borrowers. The current account imbalance theories stand discredited till there is some response from Brad on whether the China Treasuries are used to fund USG expenses, or US consumers’ imports. Yet, Brad Setser has made a contribution by pointing out that both lenders and borrowers are important.
If you read the Geithner plan outline for homeowner assistance, largely, those who owe much more than the market value of their homes aren’t going to get much help, and those who have loans above the conforming limit aren’t, either. The total outlay to help borrowers is a sad $ 85 billion, plus another $10 billion in baksheesh (tips) thrown in somewhere or other.
After tipping borrowers at 10% of the TARP bill, and a small fraction of the new lendings to banks, the US can hope for a situation where lower consumer confidence will create what Brad Setser might call ‘contractionary forces’. This will be the main impediment to recovery.
As for the dream of recovery through increased exports, especially to China, we’ve had sufficient discussion on that point.
Speaking of Harvard and the new Harvard plan for a new Harvard Science lab(presumably costing millions): It’s well known that despite their intelligence the local American students are so much given to having an easy life that they refuse to do anything that involves hard work. Later it is claimed that students from Eastern Europe, Russia, China and India are inherently superior in terms of mathematical ability; this is why they do better on average and fill up the science labs and engineering schools.
The typical American student’s idea of a Harvard education is something like football, rowing and international *affairs*.
These days this problem has spread to areas like macroeconomics. People are being allowed to graduate from with a Ph.D. from places like Harvard and Oxford without having a basic understanding of imports and exports that even high school kids in many countries have. Think of Dr. Brad Setser and Dr. Roubini. One is an Oxford Ph.D and the other is a Harvard Ph.D.
Both of these ‘experts’ don’t understand that when the US Treasury issues debt, irrespective of who subscribes to the debt, the money is used to finance the US Govt. expenditure. They insist that the US Treasury pays for the US imports with the money.
This assertion is made with terminologies like “the US External Deficit”, “Financing the Current Account Deficit”, address “Trade Imbalances”, etc.
If this is the standard to be followed later by the Harvard graduates in public life, Harvard might as well blow the money on million-dollar football stadiums, instead of science labs. At least,this will prevent clever Russians from using those labs to become geologists who find more and more Central Asian oil.
“The typical American student’s idea of a Harvard education is something like football, rowing and international *affairs*.”
???
Do you have any idea how stupid you are here?
@Ian: Unfortunately it isn’t possible to get an explanation of inconvenient points out of Brad Setser without launching these broadsides on the alma mater.
In any case, there’s no scientific evidence proving that people from dusty underdeveloped places are born with superior mathematical or scientific skills; so American laziness seems like a better explanation for why those people dominate those fields.
Indian Investor:
“Both of these ‘experts’ don’t understand that when the US Treasury issues debt, irrespective of who subscribes to the debt, the money is used to finance the US Govt. expenditure. They insist that the US Treasury pays for the US imports with the money.”
What?
Treasury bonds finance the total U.S. public debt, which, yes, has been accumulated through prior expenditures, but which is constantly rolled-over, with only interest being paid out of current budget expenditures and tax receipts. But the total pool of outstanding Treasuries forms a large pool of fungible investment capital. Treasuries sold by domestic individual or institutional owners to foreigners for US$ release US$ into the domestic economy, which then can be used to purchase foreign imports, or invest in foreign equities or invest in domestic assets, such as mortgage bonds, which mortgages can be used for refi to enable MEW, which enables the purchase of foreign imports with US$, which then need to be recycled either into purchases of U.S. exports or invested in U.S. assets. Take the Bushevik tax cuts for the wealthy investor class, which basically just “exchanged” a tax liability obligation for a public asset obligation. But then those wealthy investors effectively sold them to foreigners in order to invest the proceeds abroad in foreign equities and FDI, at much higher rates of return. Chinese and other foreign purchases of Treasuries recycled foreign trade-surplus dollars back into the U.S., lowering long-term Treasury rates, which serve as a “risk-free” reference for other long-term rates, basically helping to keep long-term rates lower than they otherwise might have been, thus helping to stoke the bubble in excess credit-liquidity, which went in good part into the creation of mortgage securities that fueled the housing bubble. Surely you know all this? So what point are you trying to make about a mistake in “current account imbalance theories”?
Indian Investor: “In any case, there’s no scientific evidence proving that people from dusty underdeveloped places are born with superior mathematical or scientific skills; so American laziness seems like a better explanation for why those people dominate those fields.”
This is again shockingly stupid. You have no evidence, therefore a sweeping insult against an entire population is the response of choice. You’re an idiot, or worse.
indian:
Even when I go to Wal-Mart and buy Chinese stuff for CASH, economists STILL say someone is “Financing the Current Account Deficit” and the government STILL issues Treasuries to pay for stuff.
It makes me feel like I’m being blamed for something I didn’t do!
I wish someone would get to the bottom of this BS.
@john: Thanks a lot for the good explanation. Would you agree that if there had been a rule that: say, only 60% of monthly income can be owed in monthly EMIs; and that loans can only be made after detailed verification of income, identity, etc; – the above cycle could have proceeded for ever – till such time the physical demand and supply in the housing industry – i.e. total units of a certain quality versus US population reaches an equilibrium?
Next, there are many countries that have strong controls on retail origination of loans, ensuring lower risk of consumer bankruptcy.
What prevents other countries from using the same strategy as above?
Your answer will tell you the real story – a deliberate design ensuring painless fiscal deficits for the US Govt. through geopolitical influence.
The error in current account imbalance theories is that those imbalances have been there since at least the end of WW II and the establishment of Bretton Woods 1944 – by deliberate geopoltical design, as a direct consequence of US foreign policy.
If at all we’re reasoning with them, we need to start with Bretton Woods I rather than BW II.
@Ian: Which population am I insulting, according to you? Indians shouldn’t feel bad if I state that they aren’t born superior to other peoples – tho I should have qualified it as relatively superior, perhaps. There’s plenty of propaganda that claims that people from emerging markets are born with superior math skills; I think that American students take life easy more than those people and that’s why this anomaly exists – if you have any evidence that Americans are born with relatively inferior math abilities I can consider that.In any case a large percentage of today’s Americans are just grandkids of people from various emerging markets, so this looks highly unlikely to me.
Indian Investor, I re-quote: “The typical American student’s idea of a Harvard education is something like football, rowing and international *affairs*.”
So your typical American is not just lazy (which you have no data for), but so blindingly stupid as to believe their own finest institutions are for what – ROWING?! Your opinion is worthless.
indian:
It is Darwinian. You take the top .1% of a Asian and Indian population of 2.5E9, have their governments provide them with scholarships to American engineering colleges, and tell them the scholarship is pulled if they get less than a B average, then American news journalists marvel at how Asian and Indian brains are wired different.
At my alma matter, Purdue, which was ranked top in the country for my undergraduate major, we had numerous instances of foreign student suicides around exam time. This is also Darwinian, and I put a notch in my math book every time one of them dived out a dormitory window. Since I ended up on the Dean’s list, I felt responsible for killing off quite a few of the invaders, but ultimately I realized this just makes the population stronger.
Indian Investor:
O.K. The U.S. has been running a dollar-kiting scheme. I broadly agree. The old “exorbitant privilege” that goes with being the global economic and military hegemon. But then, Ricardo aside, there never has been exactly global equal exchange. And now the U.S. has come against the limits of its long-running scheme, not least because of the exorbitant extent of its recent abuse of its privilege. Still, if you want to go back to BW1, (at which time, an independent India did not as yet exist), then perhaps you should go back to Keynes’ original proposal, including his “Bancor” system by which responsibility for re-balancing trade deficits would primarily lie with surplus countries. Which was nixed by the Americans, in favor of the IMF, (since the Americans were then not just the overwhelming dominant industrial power, but by far the world’s largest creditor nation, not least toward the British and their war debt). Keynes aim was to revive international trade in goods and allow countries to maintain domestic economic policy discretion, while discouraging free flows of international capital. His trilemma solution. Also you might google the 1948 Havanna charter, which was actually ratified IIRC by some 60 nations, probably by the new India among them, (since that would have been most of the non-communist nations in existence then), except for one key nation, the U.S., which scuttled the deal, in favor of GATT, which was originally supposed to be a stop-gap, but became quasi-permanent, until transformed into the WTO. Still there was not, nor has there ever been an equal beginning, assuming epochal beginnings could be defined or dated. And it still would have taken a long time, under the best of circumstances, for recently decolonized, newly independent nations to catch up and converge in their development with the established nations of “the West”, even prescinding from their own internal difficulties and inequalities. But the question now is: given that the Wall St./Pentagon/MNC imperial complex has finally dug itself into such a hole, what’s next?
@John: Thanks for another prescient analysis. Also, either you’re more geopolitically neutral and perhaps less politically constrained than people like Brad Setser to express your views.
Me: There are basically two challenges right now. First, to revive the domestic US economy and second, to continue the global hegemony.
Let’s start with the second challenge first. The conflict in Afghanistan appears to be an attmept to conquer a foreign territory on the pretext of anti-terrorism, rather than an attempt to bring the actual terrorists to book. Control over Afghan territory is key to maintaining and extending control over the logistics of transporting central asian oil and gas. Hence this is key to the US dollar denomination of petroleum trade and continued accumulation of USD in cartelized oil-exporters’ central banks.
The other leg of this are the ongoing negotiations related to carbon emissions. Once you have stringent controls on carbon emissions, with carbon trading, etc that system can be used to further extend the US dollar hegemony through a similar system of specified bourses for the trading, controls on curreny denomination of that trading, etc.
Now, coming to the domestic economy. It’s clear that the US Treasury is actively working to create a functioning system for credit extension either by way of re capitalization or by way of new credit extensions, etc. On the other hand there have been massive decreases in personal net worth of borrowers due to the housing price collapse, and there isn’t a comparable effort to cancel consumers’ debts.
I would assume that utlimately Treasury will succeed in creating a functioning credit system. But according to me recovery depends at least as much on consumer confidence in their own ability to handle their existing debts as in the lenders’ confidence in extending new credit to consumers based on their better books.
…
@john: Suppose you assume that soon we will have a set of banks able and willing to extend credit to consumers.
New borrowings will likely be favored by the following categories of people
a) those who owned their homes outright and weren’t affected as much (35% of US homes don’t have a mortgage on them. this is assuming that they are not otherwise seriously hit by the crisis, for instance, they haven’t lost jobs.
b) those who owe just about the same now on their homes as the market value (either new buyers or people who’ve been paying their loans for quite some time and in still in good overall financial shape)
c) those who have a strong preference for staying in their homes and also have an income to continue payments, despite owing much more on their homes than market value
d) various other categories of people, for instance people in professions that have been bolstered by the crisis; such as balance-of-payments economists, and bankruptcy attorneys.
You could go on with this sequence, and after looking at both sides, including likelihood of further foreclosures, etc you would conclude that a slow recovery in consumer demand will start once there is a functioning credit system.
@john: If you assume that no further assitance is given to borrowers. Consumer demand will probably plateau. There is a risk that some more foreclosures will happen even as the existing plans to stop a large number of foreclosures take effect, since a number of categories of people are still ineligible for help.Also, the plateau in aggregate US demand will mean the continuation of low interest rates.
This means a steadily weakening USD, huge amounts of USD funded carry trades, and the passage of somewhere between 2-3 years optimistically, before consumers work off the effects of the 2008 credit crisis. Employment levels are likely to languish in the interim.
Of course, all this doesn’t mean that stock markets will continue to fall. Once the above direction becomes clear and anticipated in the market, you get a bottom, followed by range bound trade in a band above it, till a new boom can start.
@john: Things can improve from the above int wo major ways. If there is a massive private equity led infusion of capital to commercialize some new technologies, that can create much higher employment levels and general growth.
Secondly if Roubini’s proposal to provide an across the board 30-40% cramdown to all borrowers, nationalize the whole banking system, and re privatize it is actually adopted, that can in a way nullify the entire crisis for the US economy. Of course this is politically difficult and unlikely.
The Treasury might also consider exchanging a large cramdown agreement with banks for a large re capitalization through leveraged Fed re capitalizations with neccessary authorizations. But they aren’t considering that as yet.
Right now the Treasury focus is on the task at hand, which is to float a working banking system.
Also, a private initiative led shift away to electric cars, or any other such development, can lead to a new boom in the interim.
@john: Increasingly you notice how great world leaders come over to my point of view after I first develop my opinions. I’ve been declaring a market bottom since Feb 03, and now Ben Bernanke, the Federal Reserve Governor, says that the recession may end in 2009:
http://finance.yahoo.com/news/Bernanke-Recession-may-end-in-apf-14453719.html
Earlier I went on about infrastrucuture sector opportunities in India and Geoff Immelt endorsed exactly my views in a CNBC TV18 interview.
But I suspect it will be many many years before the Harvard rowing team gets dismantled.
Please excuse typos and grammos in above posts, and it’s Jeff, I think
@john/others: My previous stance on the equity market was a Nifty bottom on Feb 03; though it is marginally today than it was on Feb 03, I think I came very close to calling the bottom.
However I was uncertain about the US equity markets and didn’t offer a confirmed view. But after careful reflection, I think that all various possibilities and options for banking bailouts, etc; all possibilities for further implosions and contractions, etc … everything negative that you can think of is now already priced into the US stock market.
People who go long in the US equities now will reap a tremendous profit in the medium term. Basically, the Dow has bottomed out now.
And I’d like to clarify what exactly I mean by bottomed out. The Dow is now going to look forward to improvements in the situation, and it has already accounted for negative probabilities. So for instance, if 2 major banks are nationalized, the Dow will fall a bit to reflect the direct equity washing. But it will then rise again in response to the resultant improvements in credit.
And no amount of further negative developments can now make the Dow fall much further from where it is now.
For a medium/long investor the time to go long has finally arrived.
brad, can you please ban/moderate Indian Investor? he has 13 out of 21 comments — only one of them relevant to dubai — and has added stupefyingly idiotic generalizations and personal attacks. i cringe whenever i visit this blog now as i know your thorough analysis will be inevitably followed by this megalomaniac’s self-promoting. it leaves a bad after-taste in my experience as a reader and frankly you’ve tolerated it long enough.
Te Administration could agree with the banks to give them $3.5 trillion in recapitalization, in exchange for across the board cramdown of around 30% on all mortgage debt. Operationalize this by lending the remaining $350 billion from the TARP to the Fed; the Fed would be free to behave as a bank and leverage the amount up to buy equity in banks. Next, make a rule that not more than 60% of monthly income can be owed in EMIs going forward, and verification is needed for all loans – Know Your Customer guidelines for banks.
Nobody can easily object to this plan. Even diligent savers will welcome a 30% cramdown on their debt. Only those who own their homes outright will be left out of this. But even they would probably appreciate the benefits of a sharp US economic recovery.Also, this solves the political difficulties arising from having to nationalize banks. If the establishment wants to play favorites with the banks it can still play favorites in who gets the re capitalizations and who is left out.
Congress can’t argue that it’s undemocratic, because 65% or more of the population will benefit directly.
Just help both the borrowers and the lenders, and the problem is solved.
I second the comments of Anonymous of 4;10PM.
This doesn’t have anything to do about Dubai, but then again who knows anything about Dubai?
But anyway, I feel obligated to offer Schiller equal time in an effort to add color to Legendary Indian Investor’s and World Leader Bernanke’s pronouncement to Congress that the recession is ending on schedule and it’s a great time to buy US and Indian stocks.
Schiller says stock market valuations are at about the historical norm. The S&P 500 would have to drop another 30% to reach valuations hit in previous recessions, like 80-81 or 73-74. He uses PE ratios in his analysis.
That doesn’t mean the market will go that low, I always underestimate what dropping bucket loads of money on banks can do. And we still have more capital floating around today than in the past.
But don’t leverage up the farm and dive into stocks just because World Leaders say you should. Remember, you are not the Fed.
P.S. What’s wrong with rowing anyway?
Yes, please, bad comments drive out good. I know mine weren’t productive, but you wouldn’t read them at all absent some of the more trollish people here lately.
@Ian: What do you think of the idea that 30% of the mortgage debt gets wiped off consumers’ books, they follow a new rule as to how much of their income they can borrow; the banks get the same amount as a recapitalization – it goes through the Fed so the requirement of $3.5 trillion for this can be met through the remaining TARP?
@Ian: If you don’t know the importance of rowing and football versus science at Harvard, obviously you didn’t study there …
OK, on popular demand, let me stay away from posting on this blog anymore.
In any case the best idea I think I can come up with is just to cancel a chunk of the borrowers’ debt, and give that chunk on a leveraged basis as capital to the lenders, using the TARP.
The Dow closed at 7350 today. All medium/long term investors are advised to go long.
Pip pip.
Also, leaving last words on the blog:
a) What I’ve described above (Afghanistan + carbon trading) is the actual strategy in the US foreign policy. I don’t neccessarily endorse it; it’s just my observation of events.
b) There’s plenty of risk of a terror attack on US/British soil, because it looks like the US/UK/EU/Russia interests are all converging and some kid of a deal is the offing. If the Taliban get diplomatically isolated, then Pakistan’s ISI might get the Al Qaeda to perform another terror attack. It goes without saying I don’t endorse this either.
c) Equity markets have bottomed out. Short sellers, be careful. People going long just wait patiently, even if there are a few further falls there isn’t much of a downside to 7350 in the US. Now I’m pretty confident about that.
d) Always be careful to examine all numbers and theories before accepting theories or recommendations. When you read long writings, focus on the bottomline recommendations and see what the actual implications are.
Indian investor — thanks for your past contributions. I am going to hold you to your commitment that these are your last words …
too bad more folks don’t want to talk about the challenges of bailing out an over-indebted city state.
brad,
In addition to some of the more economic elements you mention above about why it is the UAE and not Abu Dhabi that came to the rescue, I’d imagine there are some political and institutional reasons. In fact, even before this there were some nascent moves of strengthening at the the UAE level (eg the creation of the CB’s liquidity facility etc).
though maybe its just a time buying effort. I’m waiting to see exactly how the second tranche goes through
Bye Indian,
Perhaps there is a blog bubble occurring…Or perhaps irrational exuberance is a characteristic of our species. A source of our creativity?
As always its fun while it lasts. After all nothing is perminant.
This seems to me a very interesting question. I’d like to know what happens with Airbus and Boeing orders in the current environment. DAE capital made a big deal with Airbus at the end of 2007.
Anyway today Abu Dhabi IPIC is currently negotiating the purchase of a big chunk of CEPSA in Spain, wich is down 30% today. The seller is Santander, owner of of 31,6%. Everybody seems to have some trouble this year.
http://www.aviation.com/business/071112-airbus-dubai-orders.html
http://www.cotizalia.com/cache/2009/02/25/noticias_98_santander_confirma_negocia_venta_porcentaje_cepsa.html
Agree with Rachel,
Politics definitely played a part in the structure of the Dubailout. Interesting to note that several Dubai civil servants occupy senior posts at the CB – although there’s no doubting Abu Dhabi role as main decision taker.
Abu Dhabi also has competing spheres of influence with Mohamed Bin Zaed widely believed to be the main decision maker.
I find it hard to believe that the federal debt really does come with no strings attached though and expect further centralization of the emirates’ economies soon.
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