Saturday, November 28, 2009

Dubai World Crisis Vs US Housing Crisis - Layman's Analysis

(Image courtesy - Wikimedia foundation )

I think this is the following layman's assessment

US Crisis Model -

1) Government Pushes Expansion of Housing as it sits on huge surplus/potential surplus. Keeps interest rates low for borrowers

2) Lenders fresh with bulk funds from investors and low interests push both consumers and constructors. (initially follow all regulations) Steady growth in prices of property

3) Once responsible borrowers have bought houses/property - Greedy Investors, Greedier Realtors push prices higher - and entice borrowers with poor credit history to buy houses. Investments Banks bet on these borrowers defaulting through Credit Default Swaps and Collateralize Debt obligations

4) At the tip of the bubble (mid 2006), the frenzy of buying starts faltering with the irresponsible borrowers (who bought in the 90s) start defaulting. As homeowner defaults increase, demand slumps due to lack of growth in economy, flood of cheap foreclosures in the market push down prices.

5) Even good houses and responsible borrowers start feeling pain as bad borrowers brought down all real estate asset prices. (with many of them also either forsaking the house or short selling for a loss)
- this results in IBs and insurance cos to forcefully pay the CDS and CDO - making them insolvent.- BAIL OUT BAIL OUT

BOTTOM LINE for US market
Borrowers (end users who bought houses) started defaulting because they owed banks more money than the value of the house.

Dubai Crisis Model -

1) Government of Dubai entity/organizations plan grandiose development for the city.
They evaluate the scope and possible returns and borrow money from investors to construct projects via contractors. The entity backs it up saying never decreasing oil prices will make Dubai a productive hub. So the valuation of property is based on increasing oil prices.
Update1 - Someone corrected me saying Dubai does not have oil, but the other emirates do! So Dubai just projected its potential based on the neighbors riches :)

2) Initially some sales of these projects pick up due to marketing etc. But once the credit crunch hits western world potential buyers start declining. Oil prices tumble to a point where Dubai can no longer fund projects with oil money (which it does not have - but was promised by neighboring emirates), so it steps up borrowing hoping for recovery.

3) With no buyers, and stagnant prices, there is no scope of paying back the borrowed investment money to the lenders by the Dubai world, etc entity. Dubai asks for 6 months moratorium on payments.
Companies are worried that even after 6 months, the huge amount of unoccupied real estate in Dubai will simply remain in present stagnant state. (Dubai govt/Dubai World cannot reduce prices as it will cause a downward spiral just like USA and cause present occupiers to forsake their places as nearby locations will become dirt cheap - at the same time, tight money supply is not bringing in new investors to buy Dubai property at current prices)

4) Renegotiation of Debt fails - and the Entity cries default ...

In this type of crisis, there is no end user or home occupier/office lessee involved - the Debt of the constructing entity itself causes the default mess.

There are fears that Malaysia, Shanghai and of course Mumbai are having exact same models of construction - where some entity entices investors and promises huge returns and later finds out no one wants to buy whatever was built.

I am not an expert at all this but is my assessment correct?
Where is India's bubble position wrt these 2 scenarios - all thoughts appreciated

- Outcomes -
1. Global Commercial Real Estate crash - Ruled out - Emerging market Commercial Crash ??
2. Gulf Government Bailout on Oil Bonds - Abu Dhabi is unwilling as the UAE is not really United :P
3. Collapse in oil prices due to surplus from Russia, Nigeria, Venezuela and Iran - Keep checking oil futures
4. Definite yes - cost of insuring against default by High debt nations like Ireland, Bulgaria, Greece, skyrockets

दुबई = डूब-गई


Jayant said...

Hi Shriniwas,

Thank you for the post. Following are my comments.

Where is India's bubble position wrt these 2 scenarios - all thoughts appreciated

The Indian Real Estate has already run out of steam and would have been under the debris, had it not been the bailout from The Government of India and Reserve Bank of India. The real estate companies have been hit hard and even after getting the loan restructured (Technically Default), they are raising money by QIP, FCCB etc routes. The Reserve Bank of India is shamelessly approving all these tricks being played these jokers. Please check following recent news.

Unitech seeks approval to raise $700 m through FCCB issue

25 Nov 2009, 0036 hrs IST, Arun Kumar & Deepshikha Sikarwar, ET Bureau

NEW DELHI: India’s second-largest real estate company Unitech will raise $700 million through foreign currency convertible bonds (FCCBs). The company has sought approval from the Department of Industrial Policy and Planning (DIPP) and the Reserve Bank of India to raise the fund through convertible instruments.

The company has assured the government that the fund will be used for an integrated township and not for repaying existing debts. “The company will ring fence the fund raised through this route for a dedicated project (integrated township) through an escrow account,” a senior company official requesting anonymity said.

So the Indian real estate bubble is still inflated due to Unholy nexus of Builders and Banks. It is just a matter of time before a Black Swan event/ a Tipping Point event crashes the bubble.

- Outcomes -

1. Global Commercial Real Estate crash

--> No. This is not fallout of a Dubai real estate debt rollover. This bubble has been in the making for a long time. Just keep track of how many US small, community banks which had a huge exposure to real estate sector are being closed by the regulators on every Weekend. This has led to almost bankruptcy of FDIC.

FDIC bankrupt as of 9/30/09

FDIC Proposes Banks Prepay Deposit Fees Through 2012
By Alison Vekshin
Sept. 29 (Bloomberg) -- The Federal Deposit Insurance Corp. proposed asking banks to prepay three years of premiums to replenish reserves dented by a rash of bank failures that the agency said will cost $100 billion through 2013 .

2. Gulf Government Bailout on Oil Bonds

--> Not sure of this

3. Collapse in oil prices due to surplus from Russia, Nigeria, Venezuela and Iran

--> Considering the helicopter Bernanke hell bent on printing more and more dollars, flooding the markets with the cheap money, the collapse of dollar is inevitable ( it has already fallen against the basket of currencies) and the oil prices have to go only in upward direction.

4. Deflation in all emerging markets of asset prices (dont know about housing but commercial for sure)

--> Since when the central banks have started factoring in the asset prices in Inflation/Deflation? It has never happened. Otherwise the Inflation would have sky-rocketed. So the correct term would be the "Fall" in the asset prices. Once all the stimulus money runs out and the government stops the "extend & pretend" programmes e.g. Cash for clunkers, Extension and Expansion home buyer credit etc, dead cat will start flight to the ground.

Anonymous said...

Hey Shriniwas,

One major goof - Dubai does not have any oil. The oil is with its neighbor Abu Dhabi!!!

All Dubai has is some gas(literally and figuratively), some exports and the hope of being recognized as a tourist destination.

Unlike US, Dubai is debt laden to the hilt! In the sense, Dubai has more debt than its GDP. With no collateral like Oil and only the word of Sheikh Makadum...the Default was a natural consequence for Dubai World. The recession in the West (US/Europe) is going to drag on for 2 more long years at the very least...

As Warren Buffett says -
1> When the tide goes out, you discover who has been swimming naked (and Dubai, Iceland, Ireland..have been exposed so far)
2> There is never only one cockroach in the Kitchen (i.e., now that one cockroach has been discovered, wait for the colonies of cockroaches to be discovered)

Vik said...

Good post. While you present a logical scenario, the governments and all the big banks will do their very best to control the damage thru media public relations and eventually do the same bailout which was done in in the US. The losers are going to be end-users as any equity held by them is going to be wiped out. Dubai has no bankrupcty laws and if an individual misses a payment, he goes to jail. However if a mega corporation like Dubai world cannot meet payments, there is talk of being bailed out. As per the Dubai laws all these top management nutjobs should be put in jail.

With prices down 50%, there is noone who is spared. In the US, there were only few areas which experienced that much damage. Dubai has show that sand castles can collapse faster then you can say bailout.

Vik said...

I also think that the Indian expat population is going to panic and move their funds to Indian rupees or dollars. There could be solvency issues with the local banks so why take the risk. We will also see hundreds and thousands of laborers returning back. I met a friend of mine in India last month who was put on forced vacation from his job in a Dubai hotel. They had told him to come back in March 2010, but it appears that is too soon to return. Indian ministers will deny all this, but the true story whether employees/laborers are getting paid is anybody's guess.
Tough times indeed for the migrant class. The Emirati local population has been fattened by the Sheikh and they don't do any of the labor intensive work. It is about time this bubble busted.

Shriniwas K said...

If Dubai did not have oil, isnt it the evaluators who projected these grand return from Dubai also responsible. I am pretty sure among those evaluators were the same greedy members of the Rating agencies like Moody's, Standard and Poor, Fitch, etc

Even if Abu Dhabi/ rest of the Emirates bail Dubai out, Dubai itself as a XYZ destination is useless. Islamic laws wont allow strip clubs and nude bars as Vegas does to attract tourism. Shopping Festival et al do not matter due to the Internet. I can find a nice deal online even in India than having to travel to Dubai. Dubai is F*&@ed up. I hope all those bogus Sharia funds go bust, like the dubious sharia itself. :P

At least US has good ethical standards and a strong Constitution and laws. What an Irony that the bust happened precisely on the Holy Eid days itself. Sometimes things like these make me believe that God err. Santa Claus indeed exists :)

Amit said...

Regarding commercial real estate bust.I live in Koramangala Bangalore. This morning as I walked along 80 feet road, I saw an incredible increase in the number of empty storefronts. It seems like the property renters have finally realized that the extremely high rents do not translate to break even from their revenues. I find it very puzzling why they are unable to negotiate lower rent from their landlords.

Anonymous said...

Amit, thanks for the update on commercial real estate in Bangalore. How is the housing market in Bangalore? Are you beginning to see a fall in prices?


Amit said...

I think the sellers are hanging in there. At Raheja Residency you have the same rates 60 lac for 2BHK : amounts to 60K EMI rent is 20K. At Electronics City there is a glut of unfinished villas and apartments. not sure of other locations.

Shriniwas K said...

I see Oil going back down to 40$ a barrel. I dont think US$ will fall as Jayant mentioned. The moment oil crosses 4$ a gallon petrol/gasoline, demand plummets in US, leading to worldwide oil price collapse as it happened in mid 2008. Now at 2.5 a gallon national gasoline prices, US is maintaining steady demand.

I agree that since US govt pumped lots of money into the system, it has to be destroyed when interest rates are increased, but Ben Bernanke and co are unwilling to do that till Hyperinflation sets in. hyperinflation is not setting in because the US is cautiously cut down on all consumer and small business lending, so the jobs and demand in US are taking a hit.

I am sure this has been thought out well at least by the US treasury dept and the Fed. Also you are forgetting that US sits on top of huge reserves of oil that is not drilled precisely for such crisis occasions ...

Jey said...


I'm desperately looking for a bachelor accomodation in Bangalore... I'm looking for a single room/ 1BHK but fully furnished.

The rents in Wind tunnel road and indiranagar for such accomondations are atleast 7.5 to 8.5 K per month :-(.

While there has been a decline, I'm not sure what to make out of this. Either I'm a poor negotiator or I'm looking in the wrong areas.


Education in India said...
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Anonymous said...

bobby said...

How India was able to grow at 7.9%

* Govt spending has propelled growth : Govt wage hikes, farm loan waivers, excise cuts , govt spending and monetary stimulus has propelled consumption and therefore production , which has shown a half yearly growth of 9.2% YoY, v/s 5.1% in FY09.

* With all of the above govt has contributed to 27% of Q2 GDP growth. Ex-Govt, growth would have been 5%~!

* Govt share of final consumption expenditure has jumped to 20.2% v/s 7.4% same period last year! So who's belling the cat?

* Tax collections are down 22% in April-Oct period (First half) and direct tax collections are up only 4%!

The Revenue side Fist half : Tax collections are mixed....

* Corporate tax collections : USD 20.4 bn -> up 6.5%
* Income Tax : USD 10.2 bn -> up10.5%
* customs : USD 09.5 bn - >down 32%~
* Excise : USD 09.8 bn -> Down 22%
* Service Tax : USd 06.1 bn -> Down 5.3%

Further, revenue deficit is already at 73% of budget in the first 6 months! (USD 43 bn) I doubt if they will be able to restrict expenditure for the full year at the budgeted level of USD 60 bn.

Fiscal deficit is already at 61% of budget , ie usd 52 bn (center), This appears lower as the govt has already mopped up 80% of total mkt borrowing in first 7 months! A sure over-shoot on the total borrowing by March '10.

All in all - macro risks continue.

Hard working NRI said...

India's real estate is the most ABSURDLY inflated bubble in the whole world. Most developed countries have median home prices between 3-5 times the median annual income. In many parts of the USA, this multiple is less than 2 (Texas metros, Indy etc). In the so called bubble areas in the USA, this multiple got to about 10, so there was a huge outcry that has caused the real estate decline in the past few years. In India, this multiple of median home price to median annual income is over 100 in both metro and rural areas. Just completely absurd. Very few people in the USA can afford to buy homes in India. Isn't that ironic? The housing in the USA is way undervalued, and housing in India is absurdly overvalued. Go figure !!!

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rajni sharma said...
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