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Update On Dubai World

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Abu Dhabi comes to the rescue.

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Two weeks ago, Professor Peter Atwater scribed Dubai World: The Freddie Mac of the Middle East, an excellent column with a forward-looking lens. This morning, we share a portion of a research note from Mike O'Rourke, the Chief Market Strategist at BTIG.

As of this posting, Abu Dhabi committed to provide $10 billion to help Dubai World avoid defaulting on a $4.1 billion bond payment that was due today. That default, if it occurred, would have triggered two additional defaults on securities scheduled to mature in early 2011 for an additional $1.73 billion.

We highlight some of Mike's muse as it fits with a recent theme in Minyanville, that of credibility and confidence, as it pertains to the structural integrity of the market:

The primary concerns about the potential default emanate from the fact that Nakheel's parent is Dubai World, which is owned by the Dubai government. Dubai is undoubtedly viewed as the financial capital of the Middle East and while Dubai is not oil rich, if the powers that be want to find a resolution, they can. The manner in which these events unfold will be historic for the region.

This situation is not very different than the implied U.S. government guarantee of GSE Agency MBS in this country. While the government denied its existence, a year and a half ago, Treasury Secretary Hank Paulson asked Congress for a "Bazooka" he hoped he would not have to use to backstop them. The market forced him to use the Bazooka and while the Government claims they don't have the same standing as Treasuries, if they were to default, then Treasuries would have no standing either.

This point was clearly made by J.P. Morgan in the Pujo hearings nearly a century ago. Morgan was asked, "Is not commercial credit based primarily upon money or property?" Morgan's response was, "No, sir. The first thing is character." To which the investigator responded, "Before money or property?" Morgan retorted, "Before money or anything else. Money cannot buy it." Morgan went on to explain why he was credit-worthy based on his character "... Because a man I do not trust could not get money from me on all the bonds in Christendom." That is the reason the U.S. Government backs the Agency debt even though they claim they don't because a failure would ruin the trust in the U.S. Government as a borrower and destroy its character built over 230 years.

For most Westerners, Dubai is viewed as a regional issue. The fallout will likely be highly concentrated within the region, but the region has ample resources to absorb it. This a test on several levels, culturally and economically.

The West is curious to see how investors in the relatively new instrument, a Sukuk, will fare through this process. The manner in which this issue is handled today will also influence heavily whether or not the investments in the Middle East remain solely concentrated among locals, or if the region passes the test and global investors gain renewed confidence.


R.P.

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