Friday, December 18, 2009

Sovereign Debt Default Scare - Is Dubai Too Big To Fail?

Just a year back big banks and financial institutions had defaulted big time in many developed nations, specially in US. Declaring themselves bankrupt overnight, these big financial institutions reported losses in billions of dollars on what we now know as sub prime crisis. So huge were the losses that US Govt alone injected more than $700 bn to resuscitate these dying financial institutions. Honest tax payers' money has been squandered to revive failed private US banks in one of the most aggressively capitalist nations of the world. Reason - these banks were too big to be allowed to fail. On the other hand, in 2009 alone 106 US banks had to close down, but they were not bailed out by US Fed. Reason - they were not big enough to be saved.

So what is the lesson to be learnt from here? Lesson is that as a business institution you have to bungle big time, show billions of dollars as debt in your books, borrow or leverage indiscriminately and then sit back and relax after blowing the whistle. You will face no problem because your government will bail you out since your bungling is too big. And once bailed out, you can then go about using the bailout money to enrich yourself with astronomically high bonuses. You can justify large bonuses by showing existence of big money in your books. So what if now the money in your books is honest taxpayers' money loaned to you by your government?You can be squatting smug on your haunches with the knowledge that, do what you may - you just cannot fail. You are too big to be allowed to fail!!

That is how investment bankers are using the bailout money in many countries. In fact in UK the public outrage has been such that Govt has now slapped 50% tax on bonuses that banks pay to their employees. As a result, Barclays recently announced a pay hike of 150% for 22000 of its investment bankers with retrospective effect from June 2009!! Take that - if you tax our bonuses then we have other means of looting tax payers' money.

Well so far so good. Big business institutions have been bailed out of thick financial soups by their respective governments. But in doing so these governments have become susceptible to credit crisis themselves. Governments, I agree, are again too big to be allowed to fail. And that is how we found Dubai getting bailed out by its neighbour, Abu Dhabi. For more details on Dubai bailout click this link here - http://archana-archdeb.blogspot.com/2009/12/debt-laden-dubai-when-will-woes-end.html

Abu Dhabi has given temporary reprieve to Dubai so as to maintain investor confidence in the region. But such actions of saving nations from becoming bankrupt will be possible only when there are only few and far between instances of sovereign default. What happens when most nations fall into a debt trap from which they cannot extricate themselves? Many developed European nations are on the brink of sovereign default. Greece, Spain, Ireland are some such names. Then there are a host of East European nations which are tottering under the burden of massive debt. Who will ultimately bail out whom?

The way even rich European nations are falling into debt trap, I wouldn't be surprised if lenders, as a species, totally vanish from the face of this earth. Germany is the richest nation in European Union and it also has spiraling debt in excess of 70% of its GDP. But wait a second! The biggest debt defaulter can be US in times to come. It is estimated that for the next 30 years US national debt will keep on increasing every year. Presently US Treasury has calculated the National Debt at $ 12.135 trillion. White House estimates a record $ 1.5 trillion deficit this year alone, and next 5-year deficit total of $ 4.97 trillion.

Now imagine a scenario in future when US defaults on its public debt. What will then happen to this global economy, which shook like an aspen leaf with the prospect of tiny Dubai defaulting? The total debt of Dubai, including all its state sponsored entities, is not more than $ 100 billion. Compare it with the present day US debt of $ 12135 billion. It is agreed that US is really too big to be allowed to fail. But tell me, who on this planet will be capable of bailing out US, in case it defaults??