A positive spin on bankruptcies in Dubai

February 11, 2009

In most developed countries when people go bankrupt they become dependent on a government “social safety net” and drain the nation’s resources with unproductive expenditures. Keeping people fed is important, but it’s not going to help stimulate an economy out of recession. People aren’t likely to increase consumption with diminished income from employment insurance or the credit cards they don’t have. They aren’t likely to become more productive in a job they lost. Social stabilizer, yes. Economic recovery plan, no.

In Dubai, however, since most of the wild speculative risk was taken by foreigners, as they default on their obligations, they leave the country. That means they don’t require state assistance and their abandoned assets (cars, real estate, etc) are seized and sold for a second time at a lower price. Prices will crash, but locals earn money off the first sale and locals earn money off the second sale. As long as the lenders are abroad, the loses are felt by foreigners and it’s win-win for Dubai. They get to keep the assets paid for by people no longer in the country without any of the negative societal baggage associated with poverty.

The catch is how much debt was assumed by the state and associated businesses. Dubai is known to have used quite a bit of leverage on its mega projects. They always have the option of taxation to repair the state balance sheet, but that will delay any potential future recovery. Despite the freeze, Dubai is still one of the more attractive business destinations in the world. The infrastructure is already first class and with lower prices and less traffic, even more so.

In other words, short term pain will be severe as consumption plummets, but so long as Emiraties are solvent and Dubai survives, the pain will be felt mostly by fleeing foreign investors, deported foreign workers and irresponsible foreign lenders. The city is likely to empty out considerably and lose some of its mystique, but it’s also likely to be one of the first places to recover when the sun returns… if it returns. When prices in Dubai hit bottom (not even close, yet) it could be a leading indicator of global economic recovery.