Monday, November 30, 2009

The Message from Dubai

As the situation with Dubai and its investment arm, Dubai World, has nearly dominated the financial market headlines in the last several days, there are some important observation to be made:

1) Pockets of instability that can send ripples of anxiety across the global financial system still linger on, almost 15 months following the Lehman affair. Some of these pockets of potential trouble continue to fly under the markets' radar screen- as was the case with the Dubai episode- making them potentially more dangerous when they abruptly burst to the surface. In other words, we have now seen clearly that the global financial system remains prone to aftershocks.

2) The configuration of the various players affected by those aftershocks is not the same as in the previous major round of the crisis, or, at least, those players are not affected to the same degree. In the current Dubai affair, it appears that it is mostly the Britsh banks absorbing the brundt of the seemingly inevitable default by Dubai World, and particularly HSBC and the Royal Bank of Scotland. True, both of these institutions had been among those ravaged in the aftermath of Lehman's collapse, but one cannot but acknowledge that, this time, the major U.S. banks have stayed, mercifully, out of harm's way.

3) Despite its undeniable vulnerability, the global financial system is showing credible evidence of having healed considerably from its near-death experience late last year. Of course, credit-default swap prices on various countries' sovereign debt have risen since early last week and some stock markets around the world- particularly those with close geographical proximity to Dubai- have sold off. But, by and large, most major financial markets around the globe have continued to function properly, essentially casting a vote of confidence in their own ability to weather the storm. This takes particular significance today, after Dubai refused to come to the rescue of Dubai World's debt, essentially pushing the latter into restructuring.

The entire Dubai affair may help re-inject an element of caution toward some global spread products and sovereign debt of a number of other countries. It may even help complicate somewhat the economic recovery prospects in the U.K, the beleaguered banking system of which just took a fresh hit, and some banks on continental Europe may come under renewed pressure. Nobody argues that the world has become a perfectly safe place again, so soon after the harrowing experience of last year. But, financial markets and the global banking system, wounded as they may still be, are slowly regaining a sense of balance; and this is perhaps the key message from the Dubai story.

Anthony Karydakis

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