This post by Jill Schlesinger originally appeared on CBS' MoneyWatch.com.
I heard about Dubai's debt problems before dashing out for Thanksgiving and discounted the news. It seemed likely that Abu Dhabi, which sits atop a $700 billion sovereign wealth fund, would swoop in and come to the rescue. Not so fast - we would have to wait for the Tiger Woods car crash to move the Dubai story below the fold.
Here's the best way to think about the Dubai situation: it's as if you lent a bunch of money to your nutty friend "Ned" at the height of the housing boom (Dubai World, the investment arm of the Dubai government), who said that he wants to build a spec house. You figure that Ned's uncle (Abu Dhabi, which has 1/10 of the world's oil reserves) is worth zillions of dollars, so if the plan goes awry, Uncle will make you whole. But what if Ned's uncle wants to make the 50% crash in real estate values a teaching moment? What if he doesn't bail out Ned? What if the money you lent to another spendthrift friend is also at risk?
That's what happened last week - the fear Abu Dhabi would not repay bondholders of Dubai World, sent a wave of uncertainty through investors, just as they thought the worst of the crisis was over. Without the support of the rich uncle, global markets slumped, fearing that Dubai World's total outstanding debt of $59 billion dollars could also be at risk. Investors also worried about the spread to other emerging markets.
To restore calm in panicked international markets, Abu Dhabi officials finally intervened, establishing an emergency liquidity facility. However, by saying that it will "pick and choose" how to assist Dubai, some analysts believe that potential problems with write-offs may still exist, but for the moment, there was a big sigh of relief.
While there's no need to panic about Dubai, it was a harsh reminder of credit risks that may still lurk throughout the global system and that the nascent recovery is fragile and so too are investors' nerves.
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