“At particular times a great deal of stupid people have a great deal of stupid money… At intervals, from causes which are not to be the present purpose, the money of these people – the blind capital, as we call it, of the country – is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone and there is ‘speculation’; it is devoured and there is ‘panic’.”
– Walter Bagehot, 1826-1877, editor-in-chief of The Economist
What to make of the mini-debacle now unfolding in Dubai? Is it a tempest in a teapot (and thus to be ignored), or the start of something more?
There was once a time, many moons ago, when $60 billion was a lot of money. (That’s how much Dubai World, a government-owned entity, holds in liabilities with no sure promise of bailout.)
In terms of giant, smoking credit craters, Lehman Brothers was a heck of a lot bigger. So was AIG.
And yet, while Dubai “may not be the next Lehman or AIG,” The Wall Street Journal opines, “it could offer up some nasty surprises for the world’s banking system.”
An analyst at Deutsche Bank – where they are masters of spotting the obvious – further notes, “The situation in Dubai may be a controllable event, but it reminds us how much governments are potentially on the hook for all over the world.”
Weep not for Dubai World’s angry creditors. The authorities certainly aren’t.
In response to the budding crisis, Sultan Nasser al-Suweidi, the central bank governor of the United Arab Emirates, reportedly offered this little gem:
“I have an advice for foreign investors. They should study available investment opportunities and conduct realistic feasibility studies to make sure they are real opportunities with no risk.”
Your humble editor laughed out loud on reading that. The Sultan might as well have said, “You pays your money and you takes your chances.” Or, a bit more succinctly, “Caveat Emptor.”
Dubai, you see, was a “Bubble City.” Not just figuratively, but literally – at least as far as the planners and schemers were concerned.
“A few years ago,” the FT reports, “[advertising]said that the emirate would build a ‘bubble city’… a development of restaurants and museums suspended above ground by helium balloons [ed. note: !!] and surrounded by a transparent enclosure.”
Transparently speaking, anyone willing to invest in a vision of that sort – a literal pie-in-the-sky scheme, assuming the restaurants serve pie in Dubai – just had to be an idiot. (Or perhaps a hedge fund manager…)
Thank the Economists
The Dubai foolishness begs a question. To channel Bagehot, why are investors so stupid at times? Seriously… what on Earth possesses people to pour non-trivial amounts of capital into such harebrained schemes?
On at least one level, one can blame the economists and efficient market theorists. These academic types are like bartenders who deny the existence of alcoholics.
“Rational economic man” is always and everywhere sober, these pointy-headed idiots say. And thus, if all market participants are sober, public drunkenness cannot exist in the marketplace… and thus all prices put forth by the market are rationally and soberly justified.
This moronic assertion, bolstered by layers of Ivy League credibility, encourages investors to ignore signs of mania (just as the barfly waves off friendly hints that perhaps he should call it a night). As the evening wears on, the drink becomes more and more intoxicating… but no one admits to being tipsy, let alone drunk as a skunk. Total inebriation ensues.
Pretending that bubbles do not exist, in other words, makes it far easier to grow and sustain the bubbles that do actually appear – with the government’s helping hand in most cases.
Questions and Contagion
As with the increasingly bizarre Tiger Woods affair, there are plenty of juicy details left to the Dubai story.
An undercurrent of political tension buzzes between Dubai and its rich big brother, Abu Dhabi. (Both countries are part of the U.A.E., or United Arab Emirates, but not as tightly linked as one might imagine.) Questions abound as to how well creditor’s rights will hold up if Dubai World implodes… and what M.E. investment flows will look like in the aftermath.
There is also question as to whether Dubai’s troubles will prove contagious. A handful of other countries – notably Greece – are looking very shaky. Will creditors with exposure to heavily leveraged schemes and flimsy asset structures in other locales take a hint?
In your editor’s view, those who view the Dubai trouble as “contained” are whistling past the graveyard. (Come to think of it, didn’t Treasury Secretary Hank Paulson describe the subprime crisis as “largely contained” back in 2007?)
Whether Dubai is the first domino in a chain or more of a one-off type event, investors have been rudely reminded of just how flimsy the whole rotten structure still is. When one ponders the embedded risks and mounting government liabilities, it becomes clear that stimulus-addicted Western economies aren’t that much better off than Dubai.
Then, too, there is the “when to sell” question. As we head into December – historically the strongest month of the year for equities – mutual fund managers are faced with a dilemma. Should they go for one last ramp into the holidays to cap off an über-bullish year… or let discretion be the better part of valor and book gains before they evaporate? With increasing risk of someone yelling “fire!” in a crowded theater, Dubai argues for the latter.
The True Nature of Bubbles
But getting back to bubbles… as a tutorial on the true nature of bubbles, Dubai is exquisite. (If Edward Chancellor ever updates Devil Take the Hindmost, his excellent history of manias throughout the centuries, the Bubble City will surely get a chapter.)
The thing to remember about a bubble – and the thing Dubai shows so clearly – is that it always starts with a good story. You can’t have a bubble without a story. And not just any story, but a damn compelling story. One that gets people excited… motivated… convinced on the merits of rock-solid evidence to first tiptoe in, then wade in, then dive in with abandon.
Then, too, you need a certain amount of glitz and glamour. Dubai had both in spades. The tiny outpost of just 1.2 million people (per 2006 estimates, including expats and migrant construction workers) boasted a glittering array of the most over-the-top real estate projects on the planet, including man-made, palm-shaped islands and a $650 million six-star hotel (the second tallest in the world).
Dubai was to be a financial oasis in the desert – a modern mecca of global capitalism. The Middle East needed such a place… global capital flows could easily support it… and big brother Abu Dhabi offered a psychic backstop in the form of hundreds of billions’ worth of oil money right next door.
Investors considered all these things and effectively decided that, given the opportunity, no price was too high to pay. And that is exactly how bubbles form. The compelling nature of the story, combined with the age-old influence of human nature (and investors’ love of a good thrill ride), leads to the taking of a good thing and blowing it all out of proportion.
This is why, when it comes to investing, valuation is critical (as my friend Kent said yesterday). When it comes to riding along for the long term, it is not just the power of the story, but the price one pays that makes the difference.
Will bubbles ever stop blowing? Probably not. After all, the psychology of the Dubai fiasco would be instantly recognizable to Walter Bagehot, and he died back in 1877 (note opening quote). When it comes to flights of fancy and full-on departures from reality, the Dubai fiasco was far from the first… and it will certainly be far from the last.