Dubiety* about Dubai

*Word of the Day

The request for re-scheduling payment of principal on a maturing Islamic bond caused some screeching by the bears who are trying to start a bigger fire on fears of "what else" ?

First, what is Dubai ? Dubai is a sheikdom within the United Arab Emirates which itself is a federation of seven independent emirates. In classical terms, it's a city-state run by a monarch. How big is it ? Dubai has about 1,000,000 people, but only 20% are citizens. The rest are ex-patriates and guest workers. Where did I find out this information ? Not from any news reports or newspapers stories. They lazily don't tell us. I went to the US State Department website.

Dubai created a number of development companies to manage its hotels, tourism and port businesses. The company in trouble is a real estate company. Gosh, it's such a shock that a real estate company in a formerly "hot" location would get into trouble in a global recession.

What is an Islamic bond ? I don't know, but from poor descriptions in the press, I get the impression it's like a sale-leaseback, where the property/assets are sold to some legal entity, and the seller (borrower) pays rent, not interest explicitly, to the lenders. After some time, the seller buys the property/assets back. So an Islamic bond seems like a sale-leaseback coupled with a fixed price repurchase agreement. The analogous structure was rather common in the US until the mid 1970s until new accounting rules offset its legal and security benefits.

What does this highlight ? The economic risk in ANY debt that requires a large payment of principal at maturity ( a "balloon") is MUCH higher that any debt that requires small payments over time, like a home mortgage or a sinking fund bond. If the maturity happens to fall in a period of economic stress, the likelihood of trouble in re-paying that bond hugely increases. That's why the junk bond market gets hit so hard in recessions, yet recovers so fast when the ability to refinance resumes. Analytically, you can see that the correlation of risk & reward to the economy for balloon debt is much higher than for debt that amortizes slowly.

The bond markets started to prefer bonds with fixed balloon maturities in the 1970s. They were wrong. What made trading easier incurred more economic risk which was not compensated in interest rates. The old ways were better. Bring back sinking fund bonds and mortgage bonds.

OK, I am rambling. Yup. But the Dubai debt rescheduling is the screech of a mouse. No big deal at all. It's about like Las Vegas - another city in a desert - defaulting on a global scale. Smaller, even, as oil-rich Abu Dhabi is backing the Dubai banking system. Those banks probably own a majority of the debt at risk. Thus, it's even less that a default by Las Vegas, It's like the default of a few casinos. Hmmmm ... gosh, that's already happening in Las Vegas. Yawwwwwwn.

Actions

I'm cautiously making some speculative buys. I picked up some S&P calls on Friday and some HBC calls, too. I'm phasing this speculation in to see how this panic unfolds. I think it will be over in a few days. On Friday the US jobs numbers comes out. I expect a good number and then a rally to new recovery highs.

Word of the Day

"Dubiety" - noun [$10]
Dubiety means 1. a feeling of doubt; 2. a doubtful matter
Sentence: The debt rescheduling by a major Dubai company is causing a return of dubiety over any heavily leveraged nations.

NOTE: did you notice that poetic title, with its alliteration, assonance, consonance and internal rhyme ?