TOPICS > Economy

How Will Dubai’s Shaky Economy Affect the World?

November 27, 2009 at 12:00 AM EST
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Margaret Warner talks to economic expert Simon Johnson about how Dubai's weak economy will affect the rest of the world.
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JUDY WOODRUFF: For this week, the Dow lost one-tenth-of-a-percent; the Nasdaq fell four-tenths-of-a-percent.
Margaret Warner has more on all this.

MARGARET WARNER: And for a closer look at the Dubai story, its implications and the connection with the financial crisis, we’re joined by an expert we have often turned to in these matters.
Simon Johnson is professor at the Sloan School of Management and senior fellow at the Peterson Institute. He is a former chief economist at the International Monetary Fund.

And, Simon, welcome back.

SIMON JOHNSON: Good evening.

MARGARET WARNER: So, first, briefly explain, what is Dubai World? Is this a private company or is it essentially the Dubai government?

SIMON JOHNSON: It’s a state-controlled company and state-owned, as far as we know. But it is not the state. It is not the sovereign.

So, it is possible that Dubai World could default on its debts, for example, and that wouldn’t be a default by the Dubai government.

MARGARET WARNER: So, why can’t Dubai World pay its debts? What is it, $60 billion?

SIMON JOHNSON: It’s a property company, by and large. And as far — it owns properties around the world, by the way, but the — the real money that they have spent and the money that they have lost, I think, at this point, is in Dubai.

They have built extravagant, amazing properties, which we just saw in the news report. And many of these properties are vacant. They aren’t generating any income right now. And I think they have just run out of cash.

MARGARET WARNER: Well, is Dubai in worse shape than other places? I mean, there are other places around the globe where property values have fall 25, 30, even 40 percent. But we haven’t seen, have we, anywhere else a government-related entity like this essentially saying they can’t pay?

SIMON JOHNSON: Well, we have seen some other spectacular collapses, of course, such as Iceland last year, and some more…

MARGARET WARNER: Well, yes, right away.

SIMON JOHNSON: Countries in the Baltics, for example, most of Eastern Europe is very much still in trouble.

But, of course, what is striking about Dubai is that it is in the oil-rich part of the world. Oil prices are pretty high, close to $80 a barrel today.

And what we are looking at is a very strange relationship between Dubai and Abu Dhabi, which is part of United Arab Emirates, and has an enormous amount of money, maybe $800 billion, perhaps more, in cash, liquid assets outside the country. Dubai’s debts are big, but very small compared to what Abu Dhabi has. So, how are they going to sort this one out?

Will Abu Dhabi help Dubai?

Simon Johnson
MIT
They have built extravagant, amazing properties, which we just saw in the news report. And many of these properties are vacant. They aren't generating any income right now. And I think they have just run out of cash.

MARGARET WARNER: So, why wouldn't Abu Dhabi stand behind Dubai World?

SIMON JOHNSON: Well -- well, Abu Dhabi has stood behind Dubai before, behind the government of Dubai.

MARGARET WARNER: Yes.
SIMON JOHNSON: It has helped them out quite a bit in the last 12 months.

But I think there is a -- there is a feeling of annoyance, as far as one can tell. These are very nontransparent structures, what we're talking about. But there's a feeling -- a fairly justified feeling -- of annoyance that -- with regard to Dubai's overspending and over-exuberance in the boom.

And the question is, when is Dubai going to change the way it runs its businesses, including those various vulnerable parts of its portfolio, of which Dubai World is the most spectacular?

MARGARET WARNER: Now, Dubai World is in negotiations, of course, with its many creditors. Who are these creditors? In other words, who stands to take the first, most immediate hit here?

SIMON JOHNSON: Well, as far as we know, it's European banks, and predominantly European investors. They have been drawn to the Gulf, and they were sold the idea of Dubai as a destination and as a property investment based on its proximity to Europe, in part. So, British banks are in this one pretty heavily, and some -- at least one Swiss bank, for example.

And, also, there are Asian companies involved, construction companies, for example, out of Korea who have already been impacted today. And there are companies, for example, in Russia and other parts of the former Soviet Union that sell a lot of steel that ends up one way or another in Dubai. So, it's all interconnected in complicated ways.

MARGARET WARNER: And so, in this negotiation, essentially, the banks will have to take what was referred to here as a haircut. I mean, is that what they are aiming at here?

SIMON JOHNSON: Well, I think that it is a standoff. And it's a very complicated game they are playing with Dubai and Abu Dhabi, trying -- they are trying to say, if Dubai World defaults, this would impact Dubai's reputation, it would impact the reputation of the seven emirates together, and that will hurt Abu Dhabi's reputation.
Now, how much does Abu Dhabi care about that? How much they are willing to put in? The betting right now in the market is, they will help Dubai to some degree, but it is not 100 percent bailout. Their -- their patience has been tried a little too much.

Potential for ripple effect

Simon Johnson
MIT
Now, Dubai is a very unusual place. So, it could be, people say, well, that's just a very strange one-off situation. But it could also be they look at countries that depend on foreign capital coming in, for example, in Eastern Europe.

MARGARET WARNER: So, what are the -- what is the wider potential fallout here?

I mean, could this have, for instance, a contagion effect, a ripple effect, trigger another credit crunch or crisis of confidence that leads people, investors, to pull back?

SIMON JOHNSON: It is certainly a possibility. I wouldn't want to rule it out.

I think there's direct effects, the impact on particular banks in the U.K. and in some parts of continental Europe, we have to look at very carefully. And there's indirect effects on the confidence that people have in various kinds of countries and places that are like Dubai.

Now, Dubai is a very unusual place. So, it could be, people say, well, that's just a very strange one-off situation. But it could also be they look at countries that depend on foreign capital coming in, for example, in Eastern Europe. They look at companies that are very...

MARGARET WARNER: Well, Russia, right.

SIMON JOHNSON: Russia, for example, companies that are state-owned or state-controlled, but not exactly the state. Will they receive the same kind of backing from the Russian government as one assumed a week or two weeks ago? That is the kind of reassessment of risk that is going on right now.

MARGARET WARNER: Now, there has been a lot of talk just here in the states about a commercial real estate crunch coming, credit crisis coming. Is Dubai, do you think, different enough, the lavishness, the excess, that it is not -- it doesn't reveal anything about what could happen elsewhere? Or could it be the canary in the mine shaft and that it shows the vulnerability to large commercial real estate overleveraging?

SIMON JOHNSON: I think it is a canary in another mine shaft, but there is no question that commercial property in the United States is in bad shape. It is going down. And there is a lot of genuine worries about that.

Now, Dubai might serve as a symbol. It might focus a little bit more attention next week, but I think Dubai is most about emerging markets. Our own problems are very much about the

United States. And they are very big. And they are much bigger, actually, than the problems in Dubai.

U.S. affected by Dubai

Simon Johnson
MIT
I think it is a canary in another mine shaft, but there is no question that commercial property in the United States is in bad shape. It is going down. And there is a lot of genuine worries about that.

MARGARET WARNER: So, the U.S. problems, you think, are a lot bigger? That's what you're saying.

SIMON JOHNSON: Yes. Well, the total losses, the total losses from the crisis so far worldwide, which mostly concentrate on the United States, is $1.7 trillion.

We're talking about credit losses in Dubai of perhaps $20 billion. So, that's an order of magnitude, two orders of magnitude smaller in Dubai than what we have seen in the United States.

Now, the additional problems in the United States are another $100 billion, $200 billion, $300 billion, but they are coming on top of all these existing problems. They are coming into a banking system that is weak already in the United States.

MARGARET WARNER: So -- so, very briefly, do we have reason to be nervous by what happened today in Dubai?

SIMON JOHNSON: Yes, it should make us nervous. It came at a very awkward time.

Abu Dhabi is closed for business until Sunday, so we don't get to know exactly what sort of deal they will work out until at least Sunday. And, if Monday, we have New York opening without full resolution of this issue, without total clarity, it is going to be a difficult week.

MARGARET WARNER: Simon Johnson of MIT and the Peterson Institute, thank you so much.

SIMON JOHNSON: Thank you.