Tuesday, 1 December 2009

Dubious Dubai and the issue of perception...

From Wikipedia definition of a "mirage"

"A mirage is a naturally occurring optical phenomenon in which light rays are bent to produce a displaced image of distant objects or the sky. The word comes to English via the French mirage, from the Latin mirare, meaning "to look at, to wonder at". This is the same root as for "mirror" and "to admire"."

Suddenly last week, Markets reacted strongly on news relating to the difficulties arising in Dubai. Sovereign CDS protection on Dubai significantly widen on the news and Credit indices such as Itraxx Main and Banks CDS also took a hit. It took them a while to realised how inflated their perception of Dubai real estate companies creditworthiness was.

It was all about false perception. Similarities can be made on this story that made headlines recently. Perception of the credit worthiness on Dubai World was all about implicit guarantees from the Dubai Government. Investors invested believing in implicit support. Probably the same investors who believed in the sacro-saint AAA rating issued on dodgy CDOs and CLOs as a gauge of credit quality of the underlying pool of assets in the structure. Probably the same investors who believed that a callable LT2 bond will be called on the call date by the issuer, because it has been market practice in the past. How suprised they were when Deutsche Bank, nearly a year ago in December 2008, decided not to redeem some sub debt on the date of the call! Investors trade sub debt based on the date of the call to calculate the price of the bond.

This shows you how short memory is on the market and how perception can affect sound judgement.

I travelled to Dubai in October 2008 and I went to Cityscape 2008 (as per the picture above, all rights reserved). For me it was an eye opener on the real estate bubble in Dubai. As equities market were getting crushed following Hank Paulson's fateful decision of letting Lehman go under with catastrophic consequences (when an orderly wind down could have been managed under FDIC's supervision), 60,000 "Real" Estate professionals were meeting in Dubai to have a look at the pharaonic new projects which were presented in this event. It was history in the making, the top of the bubble.

What's next for Dubai?

From the 1973 movie My Name is Nobody, here is a reminder of a little story told in the movie...
In “My Name is Nobody,” the protagonist, Nobody (played by Terence Hill), tells a famous fable:
"There was this little baby bird that fell from it’s tree in the cold of snow. It starts peeping, “Pa peep! Pa peep!” as it was damn near freezing.
Along comes this cow. She looks down at the little bird and feels sorry for it. She raises her tail and… “splah!”
…She drops a steaming hot cow pie right on top of it.
The little bird starts again… “Pa peep! Pa peep!” Because it’s hungry.
Along comes a mean ole Coyote… It reachs down easy into the cow pie and picks the little bird up. He raises the little bird higher and brushes the dirt off him real nice.
And then… “Gulp!” Swallows the little bird down all in one bite!
My grandfather says there is a moral to the story, but you have to figure it out for yourself…
At the movie’s end, the aging gunfighter, legend Jack Beauregard (played by Henry Fonda) figures out the moral to the story:
Folks that throw dirt on you aren’t always trying to hurt you, and folks that pull you out of a jam aren’t always trying to help you. But the main point is: when you’re up to your nose in shit, keep your mouth shut."

Although Sheikh Mohammed bin Rashid al-Maktoum tried to reassure the market, there was a continued sell-off in the Gulf stock markets today.

It looks like perception has changed, like perception changed for AAA ratings for structured CDOs/CLOs notes previously, and for callable LT2 bonds.

The price for the bail out of Dubai will be costly and prized assets such as Emirates airlines could possibly change ownership and end up in the hands of their powerful saviours Abu Dhabi.

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