Wednesday, December 16, 2009

Who blinked?

A better title would be who won the game of chicken?

Only the players know for sure, and they're not talking.

I refer to Abu Dhabi's last minute 10 billion dollar loan to Dubai, allowing Dubai to escape default for now.

The game of chicken
models two drivers, both headed for a single lane bridge from opposite directions. The first to swerve away yields the bridge to the other. If neither player swerves, the result is a costly deadlock in the middle of the bridge, or a potentially fatal head-on collision. It is presumed that the best thing for each driver is to stay straight while the other swerves (since the other is the "chicken" while a crash is avoided). Additionally, a crash is presumed to be the worst outcome for both players. This yields a situation where each player, in attempting to secure his best outcome, risks the worst.
The stakes of the actual game in this case of course include bystanders like the bond holders, and any adverse macroeconomic effects that might arise from a collision. As Bertrand Russell put it,
As they approach each other, mutual destruction becomes more and more imminent. If one of them swerves from the white line before the other, the other, as he passes, shouts 'Chicken!', and the one who has swerved becomes an object of contempt. As played by irresponsible boys, this game is considered decadent and immoral, though only the lives of the players are risked. But when the game is played by eminent statesmen, who risk not only their own lives but those of many hundreds of millions of human beings, it is thought on both sides that the statesmen on one side are displaying a high degree of wisdom and courage, and only the statesmen on the other side are reprehensible.
If you're like me, you'd say it was of Dubai's making (along with its not so innocent bondholders who believe Abu Dhabi would bail them out in case of default). But others take the view that given potentially adverse effects of delay, Abu Dhabi have should immediately said it would bail out the bond holders. And still others, like me again, think Dubai should have offered some of its crown jewels (Emirates Airlines, for example) as a collateral for an emergency loan from Abu Dhabi. But none of that happened, at least until the 14th of December: Abu Dhabi and Dubai were locked in a game of chicken.

So the game of chicken was played. Given that there was not a collision, there are two essentially possibilities: (1) Abu Dhabi played chicken and made a no-strings loan to Dubai, or (2) Dubai played chicken and offered collateral for the loan.

No video embed available, but click here to see how James Dean played the game of chicken in the movie Rebel without a Cause. Here's the trailer to the movie:


Blogger Abu 'Arqala said...

Part 1

I think you're correct that we don't know because the two parties who do, aren't disclosing details.

However, it is fun to speculate.
But I’d like to reformulate your question “Who blinked” to “Who’s in control”?

I think it’s clear that Abu Dhabi is.

In large part though not exclusively, I’ve relied heavily on the 14 Dec Govt of Dubai announcement. There are some risks with basing an argument on this document as to do assumes it was carefully crafted. That may not have happened for both time and cultural reasons.

I’m interested in your reaction.

First, the funding itself.
I’m reading two statements from the press release to mean that funding is being provided in stages and with conditionality. First, "The Government of Abu Dhabi has agreed to fund." Not has funded. Of course, on the day of the announcement it’s highly unlikely that funds would have been disbursed. The deal was probably struck just before the release was issued. But in following paragraph, it states that use of the remaining US$5.9 billion (after the preference to Nakheel sukuk holders) is conditioned upon Dubai World securing creditor agreement to a standstill.

While there's no way of knowing for certain at this point, it sounds like funding of the full US$10 billion has not taken place. And is perhaps intended to be phased in as needed and as milestones are met.

If true, this gives Abu Dhabi tremendous leverage over Dubai. Particularly, if negotiations with creditors are difficult.

There is I admit a second interpretation here – Dubai has the funds or will have them all shortly. And all this is designed to put pressure on DW’s creditors. And that Dubai has Abu Dhabi over the barrel. But I don’t think that’s the case. An intellectual leap of sorts on my part.

Second, the form of the financing.
It would have been quite easy for Abu Dhabi to have subscribed to the remaining tranche of the existing US$20 billion bond offering through surrogates – the Central Bank or commercial banks as recently. And much quicker since existing legal documents for these bonds were already in place. And there was ample unfunded capacity on the second US$10 billion tranche. As was clear from subsequent announcements, the actual near term cash inflow from the recent “US$5billion sale” was only US$1 billion with another US$1 billion to follow in the next week or so. The remaining US$3 billion to be funded over the next 12 months.

So Abu Dhabi's incremental purchase could have easily provided funds for the Nakheel bond.

But, as public entities, both the Central Bank and commercial banks would likely have to disclose if there were any material conditions – pledge of collateral, options to acquire assets, etc. In a state to state deal, particularly one between two absolute rulers, disclosure can be what the two parties want. There are no Central Bank or listing regulations. Nor IFRS to deal with. A state to state deal also puts Abu Dhabi’s hand a bit closer to Dubai’s throat, though there is also a benefit to Dubai. A default to a commercial entity would have to be reported. There is more opportunity for discretion in a government to government deal.

6:16 AM  
Blogger Abu 'Arqala said...

Part 2

Third, the relative positions of the two parties.

In the context of Dubai’s debt, US$10 billion is not solution. It’s temporary life support. It’s likely Dubai will need more assistance. And, there are the indications that the Emirate itself has a cashflow problem: trade creditors to the government are reportedly among those past due. As well, even with banker/investor ADD Dubai is likely to find its access to financing and its economy under pressure in at least the near term. The winding down of the real estate machine is going to have more than one wave of knock-on effects on the economy.

If so, plenty of future opportunities for Abu Dhabi to apply pressure.

Dubai’s main leverage is a Samson-like bringing down of the temple. A weapon perhaps more useful as a threat than in actual use. As Dubai will be the first to “die” if the temple crashes down.

Fourth, Abu Dhabi’s primary goals may be more political than economic. The more dependent Dubai is for financial support the more it will have to accommodate itself to enhanced pre-eminence for Abu Dhabi and to its policies and wishes. In this context allowing Dubai its flagship assets and its “face” may be small prices to pay.

6:17 AM  
Blogger John B. Chilton said...

Thank you for the comments, Abu 'Arqala.

For other readers interested here is
Gulf News report on Dubai government's statement of Dec 14.

It also deals with a Ruler's decree on the creation of a bankruptcy tribunal for Dubai World. Those words themselves may have been extracted by Abu Dhabi as part of the deal.

Abu, you make excellent points and have followed some lines of reasoning that I find interesting -- its one of those I wish I had thought them on my own things. I commend them to other readers.

My one reaction is just to underscore that we are dealing with two sovereigns here -- there is no supreme authority above that will enforce any agreement. Or to put it another way, politically I can't see Abu Dhabi using police powers to force Dubai to carry out its side of the bargain -- whatever that is. Whatever the bargain is it had to be self enforcing. One that Dubai would stick to even if the time ever comes that it finds it can't pay Abu Dhabi back.

6:55 PM  
Blogger Abu 'Arqala said...

John, agree with you.

As long as Dubai needs help, AD has leverage. On that score there was a news item on Bloomberg that Dubai had issued an order to government departments and independent commercial entities - DEWA etc but not Dubai World - to remit "surplus income" - whatever that means - to the central treasury. That I think (or perhaps more precisely would like to think) supports my earlier argument about cashflow problems at the Dubai Government level.

In terms of leverage, Abu Dhabi also has a lot of control over the Federal Administration and so could make life difficult for Dubai. Both overtly as well as just slowing down the decision making/approval process for Dubai requests.

I rather doubt there is a desire by either party to get involved in either a "hot" or "cold war". Both will find a way to live together. There is a complementary aspect to their relationship - each side offering the other something.

Any Abu Dhabi pressure is therefore likely to be delivered "softly softly" with the goal of nudging Dubai to a consensus solution.

5:51 AM  
Anonymous Raza said...

Good post. My two cents is below and would love feedback:

Here’s my two cents:

Part 1:

The Dubai government confirmed that Abu Dhabi had agreed to provide US$10 billion to help Dubai World meet its obligations, including the Nakheel bond. The remainder of the funds will reportedly be used to meet operating expenses and debt servicing costs till April 2010. The key question is what drove Abu Dhabi’s decision to provide support at the 11th hour; and, more fundamentally, what drove Dubai’s decision to announce its intention to seek a debt standstill.

In terms of the latter, given that they are the majority owners in the troubled corporates, Dubai’s authorities must have known for some time that some of its entities were going to have refinancing problems in the current global/market climate; markets certainly thought things could go belly-up very early on. Despite this, Dubai’s authorities publicly maintained, very aggressively at times, that investors/creditors need not worry. Since the Dubai authorities cannot be assumed to be obtuse or devoid of integrity – they have been dealing with markets/commercial credit for decades and would hence know the deep commercial and political fallout of a default announcement - what drove this public stance?

There are a number of possibilities: (a) face-saving/ego issues: if we stick our head in the sand, the problem will go away, or we cannot stand the shame of being forced to ask others for help; (b) expectations that the global and domestic economy would improve faster than was being projected, as a consequence of which, refinancing needs would become lower; (c) confidence in the ability of Dubai/related-corporates to raise financing on international capital markets or bilateral help (Iran, Saudi Arabia, Kuwait, Qatar or other Arab countries); and/or, barring everything else, (d) confidence in being bailed-out by Abu Dhabi due to the reputational damage Dubai’s failure would have for the UAE as a federation. Since the Dubai authorities waited right till the end to realize that nothing but a debt standstill request would work, some combination of the above possibilities may have been at play.

Working through these questions, being market/creditor-savvy, and aware of financial regulations, the Dubai authorities would have known that being arrogant and ignorant about financial problems will not make them go away – (a) can hence be ruled out.

In terms of (b), this can be discounted simply because the authorities in Dubai would have known that property prices in the emirate are unlikely to recover anytime soon given tight credit conditions (domestically/internationally), negative market sentiments (domestically and globally), and delays in project completion/start (locally and GCC-wide). Further, nearly every commentator was of the opinion that Dubai’s property prices would fall further; hence expectations of being able to secure even lower prices would keep demand from returning. That would keep the real estate sector on edge.

As far as (c) is concerned, although the Dubai government had been successful in raising financing at fairly favourable rates in October, it was unlikely that quasi-sovereign entities with large exposure to real estate (that is, no real net worth) would be able to raise financing except at prohibitively extortionate rates and that too with an explicit sovereign guarantee. Secondly, it was unlikely that market would give the amount of money needed to repay all creditors on time. And in any case, with a dismal outlook for the real estate sector, even if these corporate were able to raise financing, it would simply be postponing the problem for another day: sooner or later, Dubai’s coporates would have to deleverage, and there would not be a better time to initiate this, given a worldwide collapse in asset-price bubbles. Finally, it was unlikely that markets would commit the amounts Dubai needed at the 4 percent they had been able to get from Abu Dhabi.

3:18 PM  
Anonymous Raza said...

Part 2:

The above discussion leaves option (d) as the only possibility as to why Dubai chose to announce its intentions on November 25: Dubai always believed that it would ultimately be bailed out by Abu Dhabi simply because of the reputational damage Dubai’s failure would bring to the Al-Nahayan sponsored UAE federation, and what that would imply for the sustainability of the federation going forward; note that it is unlikely that there was a formal agreement between Dubai and Abu Dhabi regarding financial support, since if that were the case, the situation would not have been allowed to reach the proportions it did on November 25. And while it may not have been willing to accept the conditions that came linked with Abu Dhabi support, the severe market reaction led the government to concede.

Dramatically then, at (literally) the 11th hour, the government of Abu Dhabi jumped in, despite the fact that during the time between Dubai’s standstill request and the bailout, anonymous Abu Dhabi public officials had been quoted as saying that support would be on a ‘case by case basis’ – i.e., selective and not blanket. This begs the question as to what persuaded Abu Dhabi to dole out the cash, after remaining eerily quiet while Dubai made audacious statements about having Abu Dhabi’s support, in the aftermath of Dubai’s November 25 announcement and even after Dubai has announced getting support from Abu Dhabi on December 14. There could be several possibilities: the severity of the investor response and its implications for UAE corporate world as a whole forced Abu Dhabi into bailing Dubai out; the recognition that if Abu Dhabi lets Nakheel fall – a strategically important corporate for Dubai – the federation’s future would be at stake – Dubai would pull out of the federation and declare its independence; pressure on Dubai/Abu Dhabi to ensure that such a large sukuk instrument does not fail; and/or, the fear and embarrassment of what would happen if Dubai turned elsewhere for support.

If our line of thinking is correct, Dubai must have approached Abu Dhabi for financial help; it is less likely that Abu Dhabi offered on its own (the text of the press release reads “Abu Dhabi has agreed to”). And in return for providing support, Abu Dhabi may have put some conditions:

Their support will not be blanket – Abu Dhabi cannot be expected to pay for every bad decision Dubai took; put differently, Dubai must bear the brunt of the pain. This would explain why Dubai intends to continue talks on debt restructuring with other creditors. Further, Abu Dhabi could also have insisted that the bail-out funds be first used for companies whose failure would have implications for Abu Dhabi as well given the correlation between intra-emirate property markets, stock markets, and banks.

As the one footing the bill for Dubai’s largesse, Abu Dhabi would also want to ensure that it is not put in this position again. This means that since they are committed to keeping the UAE federation intact, Dubai must also clean up its act. The latter could have financial and political implications. In terms of the former, in return for help, Dubai will ensure leverage within its corporate assets is not built-up to such high levels in the future; in terms of the latter, Dubai will agree to a more dominant role for Abu Dhabi in the federal structure (or that it reign in the liberal lifestyle within the emirate and stop pursuing its seemingly independent foreign policy, particularly in relation to Iran with which Dubai enjoys very close relations). And/or, aAside from Dubai’s commitment to be more financially prudent and accept a dominant Abu Dhabi, the latter could also insist that Dubai ensures that its financial support makes commercial sense: that is, Dubai give-up some of its prized assets/shares in prized assets (DP World, Emirates Airlines, centralization of the stock exchanges).

3:18 PM  

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