In just about any endeavor, complacency can be detrimental to continued success. Many of the most successful companies in the world have risen to the top of their respective industries by always being on the lookout for encroachments on their domain. For investors, when they get used to their environment for too long, they tend to stop noticing the potential dangers that might come out of seemingly nowhere.
That is just what has occurred recently with the announcement by Dubai that they would no longer be paying interest on loans made to two of its state owned companies as they have run into financial trouble. Recall it was just a few short years ago that another Dubai state owned company – Dubai World – had wanted to buy several US ports. That only fell through due to congressional and popular opposition.
The news of Dubai’s debt deferment shocked many investors who had thought that by now problems associated with the credit markets had become all but old news. Many investors had been shaken out of their complacency and all of a sudden risk mattered again. They reacted by selling off stocks and seeking the safety of the US dollar. However, as the markets began to sort the facts from fiction and Dubai received support from the United Arab Emirates, things have seemed to settle down and all is quiet – for now.
Dubai's skyline with the world's tallest building - the Burj Dubai.
The key lesson from this episode is that investors should always be on the lookout for the potential of being blindsided and to be able to ask themselves how their portfolio would hold up should the unexpected happen.
In Dubai’s case, the fact that things have unraveled for them is no surprise at all. Throughout the last several decades, we have seen country after country receive huge capital inflows through lenders all too willing to provide loans and foreign investment racing in to take advantage of some future potential mega project. The issue is that investors never seem to learn their lesson.
The internet is rife with numerous slideshows making their way by email showing Dubai’s progress and the unfathomable statistics relating just how much construction activity was under way. The statistics certainly were impressive but seldom – if ever – did we see any objective analysis of whether or not these exciting construction projects are economical, will they be able to stand up to a global blindsiding such as we have seen over the last two years or if they even made sense. When debt is available cheaply, enthusiasm tends to get the best of even the most rational investor.
In short, complacency was on display as banks continued to make loans for projects that may not be economical for a very long time. Amazingly, some banks seemed to have thought that in the event of default, the government would simply pick up the tab. To their dismay, they are realizing that the governments of Dubai and the UAE are not going to simply step up and pay the bills. Today, many of the developments have stopped construction and the rulers of Dubai are left to wonder “What happened?” The amazing aspect to this story is that it has been repeated in country after country. In the 1980s, most of South America was left with a debt hangover, in the 1990s it was Mexico and most of Asia and today it is Dubai. Investors might want to ask where might the next unknown come from?