I’m curious to get reader views on this one, since even the normally jaundiced Reuters noted in its coverage that the 11th hour bailout was “the least expected of all options Dubai had on the table.” Abu Dhabi had made it sound as if it would help, but that it also was going to extract a pound of flesh from Dubai. Even Saudi prince Al-Walid made noised that Western banks knew what they were getting into, that is, that Dubai World was not a sovereign credit.
But as Bloomberg summarized:
Abu Dhabi’s government provided $10 billion for Dubai’s financial support fund to help repay obligations, including the $4.1 billion needed for Nakheel PJSC’s Islamic bond maturing today.
So why did Dubai World get a lifeline?
I can only surmise, cynically, that far more was at stake than Dubai World. That credit was dispensable. But the Islamic bond market (sukuk) was not. The market is only about seven years old and none of these deals has been tested in a bankruptcy. If the process was disorderly or looked skewed against international investors, it would have had much broader impact.
Part of the statement today strongly suggests that the powers that be did not want to risk the deal proceeding to court with the rules that had been in place. From Reuters:
Dubai has announced a bankruptcy law that it said could be used in case Dubai World and creditors failed to reach an agreement on debt maturing in the future.
“Dubai will announce a comprehensive reorganization law, a framework that is based upon internationally accepted standards for transparency and creditor protection,” Sheikh Ahmed said.
“This law will be available should Dubai World and its subsidiaries be unable to achieve an acceptable restructuring of its remaining obligations.”
The US had an analogous situation with the first major default of a company that had a lot of credit default swaps written on it, the parts maker Delphi. The CDS contracts provided that the CDS holder needed to present a bond to the protection writer and would then get 100 cents on the dollar (up of course to the amount of protection purchased). The problem was that far more CDS had been written than there were Delphi bonds, by a factor of about 8, if memory serves me right.
ISDA did not want the market to fail its first major test. So a protocol was invented, contrary to the terms of the CDS contracts, to allow for cash settlement of the CDS (ie, a protection buyer did not have to present a bond to get his CDS payment).
Now with the benefit of hindsight, it would have been better for the CDS market to have suffered then, who knows, we might have been spared synthetic CDOs and the AIG rescue. But the Delphi case also illustrates that those who insist on the sanctity of contracts are more than a bit naive. Contracts are modified all the time…provided the stakes are high enough. Clearly, saving millions of individuals from foreclosure doesn’t rates, since none of them individually has any clout.