Can you trust Sovereigns?
December 1st, 2009
On Thursday Dubai announced problems with meeting payments on loans for its extensive property development programme. Some investors had thought these bonds were Sovereign risk backed by the Dubai Government. In turn they expected the UUAE Government to stand behind its adventurous member state. They were wrong. The governments walked away from the debts. Markets fell sharply around the world as fear temporarily took over from greed.
It did not help that Dubai was closed for a religious festival and little information came out about the nature of the financial problem. Was it a temporary cash flow difficulty? Was it just a wish to reschedule payments? Or was it bankruptcy? World markets fell on the precautionary principal, incase losses were large, and incase they shook the foundations of weak banks and other counterparties.
This week markets have shrugged their shoulders and recovered. Word on the street is the losses will not be too large. The UUAE and Dubai governments will not stand behind the property loans, but they are making money available to local banks to prevent a run or further collapse. No one main Western bank is thought to be badly exposed. The property company borrower is in talks about restructuring the debts and selling assets, so not all the money is lost.
It was a timely reminder of two things. There is still a lot of bad debt out there, much of it secured on property which has lost value. Sovereign debt is not always the safe option. Some debts thought to have a government guarantee do not enjoy one. Some Sovereigns may also be bad debts.
We put some money into markets at the end of last week in the panic. We have always been suspicious of over-borrowed states as well as over borrowed banks. Last week’s wobble reinforced our views that investors would be wary of countries too much in debt and should remember the great debt overhang has not gone away. This was a big financial crisis, and there will be aftershocks. There will also be slower growth in the over-borrowed places as they pay off debt and raise taxes.
