A Dubai-sized shoe drops

The pinnacle of man's financial hubris?

On January 4 of next year, the world’s newest tallest building will be open for business. Dubai’s Burj Dubai tower, at 160 stories and 2,684 feet in height, make it the world’s tallest man-made structure by far and away. It will sit a mere 182 meters from breaking the kilometer barrier. Below the dizzying height of the tower lay dozens of other construction projects, together adding millions of square feet of commercial and residential space to the growing city. The building craze has been funded by financial institutions that we have come to know and love over the past couple of years as the same institutions that sold people in the west on the idea of a house as a five-year place to stay, before flipping it for tens of thousands of dollars in profit – assuring us that the price of land would always rise, so the decision was always smart.

Nobody then wanted to ask what would happen if prices stopped rising. Nobody now wants to ask, in the case of Dubai, of what happens when you build it and they don’t come.

I hone in on the impending Burji Dubai opening because I believe that it signifies what is so wrong with the decision making process that led to money being poured in chasing after what, at best, was a dream. The Dubai metro area contains some 2,262,000 people, and this decade has become home to a majority of the construction cranes in the world, as new mega skyscraper projects rise from the desert sands seemingly overnight.

Cities typically evolve into a need to have large buildings such as skyscrapers, not the other way around. Taipei 101 was the world’s tallest building in 2004, capping off a metro area that today contains just over 10 million people. In 1998 the Petronas Twin Towers held the rank for world’s tallest, rising above a metro area of 7.2 million people. Before then was the Sears Tower in Chicago, a metro area with 9.8 million people. What has gone on in Dubai is not so much the natural evolution of a city into one that needed these supertall skyscrapers, but rather the emirate playing a real life version of SimCity with the money cheat turned on.

The dream that is Dubai may still come true structurally, but what happens if it is built and nobody comes?

However, as they say, all good things must come to an end:

The government of Dubai, in a blunt acknowledgment of the severity of its financial position, said on Wednesday that it had asked its banks for a six-month stay on its schedule of debt repayments.

The terse statement came in the middle of negotiations between creditors and Dubai World, the corporate arm of Dubai, which has led many of its most ambitious real estate projects, but is now struggling under the burden of $59 billion in liabilities.

Better translation for all of that: Dubai is in danger of, if it hasn’t already, defaulting on its debt. In a world with financial institutions struggling to maintain their lucrative positions as government backing and help begins to expire, Dubai may be the ultimate signal of the other half of the housing market crisis. No longer will this merely be a crisis in housing, because the same mentality that sold banks on the idea of extending cheap credit with borrower-unfair terms to homeowners and consumers also saw the banks sold on the mentality that if you build it – no matter where you build it – they will come. The same thought process that stuck housing developments in the California desert 100 miles away from work centers stuck an oasis of ultramodern skyscrapers in the middle of what was until a couple decades ago a rather unremarkable desert town.

It gets better though, it always does.

For the banks that financed the debt-fueled ascent of Dubai — analysts’ estimates put its total debt at about $80 billion — the move by Dubai to obtain a standstill highlights a truth that many in the region had been trying to make clear to bankers. It is that Abu Dhabi, the oil-rich governing emirate of the United Arab Emirates, will not unconditionally bail out its more profligate neighbor. Instead, a genuine restructuring of Dubai’s debt, with pain being shared equally between Dubai and its bankers, needs to take place.

This is what happens when you turn on the money cheat in SimCity in real life.

Supposedly The United Arab Emirates have some $500 billion in their sovereign wealth fund, but instead of spending their selves into deficit, it appears their plan is to say that there is no such thing as Too Big To Fail in their country, even if that involves robbing Dubai of its ambition for a few years.

On the other hand, the $80 billion figure that is being tossed about is a report of outstanding debt as of the end of 2008 – coming off a period of time where oil made a run at $150/barrel. While oil is currently sitting near the highs for this year, it is still ‘only’ flirting with the $80 level. How high must oil be for Dubai’s projects to come out well funded, and how much will the rest of the world pay for it in the meantime? Still more pressing though, is the unknown of how much Dubai has borrowed since the end of 2008. Bank of America seems to think it’s more than double that:

The United Arab Emirate (UAE) has total debt amounting to $184 billion at the end of 2009, according to estimates by Bank of America-Merrill Lynch, which said the region faces a heavy redemption schedule until 2013. Dubai’s shock announcement this week that it is seeking to suspend payments on debt of its state-owned conglomerate Dubai World and property subsidiary Nakheel has roiled global markets, raising fears that the emirate which funded a spectacular building boom on a mountain of debt could default.

In the end, it is quite likely that the UAE will let Dubai twist in the wind for a bit, see its debt restructured with western banks, and then step in to back the debt at a lower price. The UAE will look like a financial white knight and Dubai’s ego will be tempered some. No matter how Dubai plays out, however, it would be incredibly foolish to think that it is the only major commercial finance venture in the world that has been turned upside down by the global recession, and will be the only one to fall or at least be severely hurt.

At more than a year after the crash in American markets and nearing the third year of the fallout from worldwide bad lending practices, Dubai is just the latest piece of evidence that there is still much more bloodletting to be had by those who thought the value of all things would rise forever.