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Dubai FUBAR

I do not understand it!

So let me explain it to you.

Since I’m not an economist, I’m qualified.

First things first. My experience with Islam as a religion has been nothing but positive.

Anyone can see that the pillars of Islam are based on profoundly moral and ethical principles.

The devil lies in the details. Including in my own religion.

Take interest payment on loans for example.

In European christian countries, interest on capital based on the duration of a loan was repudiated as immoral since the earliest times. In these modern times we all got over it and the Jews are no longer the outcasts saddled with the unsavory duty of just making fistfuls of money with nothing but money.

And yet, here we are in the 21st century and some of the richest countries on the planet are regulating themselves under Islamic Sharia Law as interpreted from reading the Koran, prohibiting any interest payment on loans. The same laws also prohibit pork and less savory vices. Bully for them.

So….ahh… how do they do any business? you may ask. Say rent a car at the airport or use a credit card or buy a house or apartment on the installment plan if they are prohibited by the State to pay any interest on any loan. Who would even be so foolish to give anyone a loan?

Beats me. I paid cash in Morocco and Egypt.

But such transactions are peanuts. You should ask me how do all these islamic theocracies borrow capital for development and investment.

Well, the way it works (even for the peanut issues) is that under Sharia laws you can still issue  a note of indebtedness,  sovereign bonds and take up loans, but instead of the usual formula of getting a percentage of interest payments and installments of principal plus interest over a set period of time, you get instead, a “participatory interest” in  a specific project for which the loan is to be granted. A bit convoluted. Does it work? Not really.

Roughly speaking, under islamic law, lenders and borrowers are quasi partners. Very roughly speaking of course, because there are some further devilish details.

Take the little detail of risk management in the huge Dubai “world” real estate projects for example.

Unless you have been living on the moon, you certainly have seen photographs of these grandiose man made islands in the shape of a Palm tree, continents and whatever. Actually, as testified by some astronauts, these projects would be just as clearly visible from the moon as the pyramids or Chinese wall.

The usual press and TV description of these projects is lunatic. Which is of course true to some extent since they are projects that came to the beloved ruler of the realm in a dream sleeping under the stars or some such. The rulers’ minions then went out to draw up a plan and then hustle for the money to make it all happen. Right away.  It’s just great to be a ruler!!

Seeing how Dubai doesn’t have much to offer, (not even much oil or gas or shade) other than burning hot sunshine, it was quite a feat to find lenders to underwrite dreams of such proportions in the middle of nowhere. Especially since there was no interest payment offered on the zillion dollar loans. Zip. Nada. But more on that later.

Considerable amounts of money for these “I had a dream..” projects came from the Islamic Financial Institution (IFI). (Don’t you just love this acronym in this context?) All such loans for example from the big brother emirate next door, Abu Dhabi of course fall under opaque regulatory principles of Sharia law, as interpreted by an equally nebulous Sharia Board.

It is simply money loaned on faith.
No big deal. I know lots of people that loaned out their money on just faith and belief and got hosed right here close at home. No need to go to Dubai for that.

But some unbelievers, expatriates, adventurous financiers and greedy bankers did just that and put up buckets full of money buying some fairly squirly and dubious Dubai bonds that clearly had emphatic warnings in plain English. (Yes, I did read them) What happens is that these gigantic goofy projects in Islamic countries present some unique risk management issues, especially when the underwriting involvement is by East-West dual financial systems with completely different regulatory and transparency requirements. One of these unique problems is that once the money is in Dubai, and the Sharia Board rules that this or that aspect of this islamic financial transaction  is not in compliance with Sharia law,  the whole falafel may or will be voided. The money goes poof! Obviously there is no appeal from the dictums of God and no cents on the dirham or dollar may be returned at all. The kicker is that any Sharia Board has complete independent control over the interpretation of what is right or wrong in Allah’s view with respect to any financial deal. Even over other similar Sharia boards which may rule differently on the same or similar issue. Precedent means nothing to the “judges”. (Personal or other relations and ex parte access such as the rulers agents may mean just a bit more). In the end, these are faith based decisions by the religious board.

I suppose that building a gigantic indoor snow skiing facility in a desert sheikdom as the outdoors bake away at 120 degrees Fahrenheit (And that is in the shade if you can find any) has got to be a fabulously profitable idea. Wonder what the lift ticket costs. One has to wonder if the motive for building the world’s tallest building in such an inhospitable environment (Just think of the cooling costs) was profitability or plain megalomania. Did the investors realize that as “partners” with investments that pay no interest they may also be responsible for the losses? And yes, the real estate market in Dubai is down and is sliding further as I write this.

When one ties financial risk to religious principles such as ancient islamic rules quasi frozen in time to complex modern financial transactions, there emerge some legitimate questions on how this can and will work.

Well, How does it work?

Here is how. A board composed of elderly well seasoned religious experts without much if any knowledge or training in basic economic principles, sit down and make up rules as they go. No big deal. Our Fed governing board does the same after all. And the Fed is not regulated or audited either. Not yet anyway.

There are however some diferences. If one looks at Wikipedia under “islamic banking” one is greeted with the superimposed bold notation that “this article may need to be rewritten entirely to comply with… quality standards”.  Yes. Indeed. Let me rewrite this hysterical article from the historical perspective.

My guess is that the proscription of interest (aka usury) in islamic law may well be due to just two interrelated historical facts.

1) When the rules were written well over a thousand years ago, time was worth little or actually nothing. So the changing value of money over time (if there even was such a change) was nothing either. and…

2) Historically, the only currency i.e. money accepted as exchange value was gold and/or silver which did not change in their relative value over long periods of time either.

Contrast that with the western history of constantly debased coinage (since Roman times) or our modern fiat paper “debt” money, constantly subject to loosing value and inflationary pressures. To return a modicum of equal value over time such money must of course pay interest.

The concept of not charging for the time value of money is closely related to the obsessive and probably intuitively quite smart habit of hoarding gold in most middle eastern societies because of the unique property of gold in retaining value.

The historically more recent propaganda statement emanating from banking circles  in our own culture, that gold is “a relict of the past” which pays no interest and has no value, completely ignores the fact that this just shiny, pretty, yellow metal has been accumulated and hoarded in substantial yet unknown quantities by islamic countries, especially those that participated in the oil bonanza in the last few decades. And behind it all, there is the relationship that has existed all along between that non interest bearing relic of gold and islamic financial principles.

The gradual step by step 400 percent increased valuation of gold (right now $1176 per ounce) over just the last ten years has only strengthened their belief regarding financial and religious principles. Faith affirmed.

It is written….Allah akbar!!

Obviously, ALL financial systems are to some extent or another faith based. And in the absence of faith in the soundness, liquidity and transparency of a financial system, the universal reaction is also the same: capital flight and removing deposits from the system.

And so we finally arrive in these modern times to the Islamic bonds. aka Sukuk. The history of the Sukuk is just about a decade old. It is the brief history of a desperate search for a vehicle to accomodate greed, need and the changing times. The news is full of stories regarding the Dubai “world” and Nakheel Sukuk which is becoming due shortly but may be declared in default before years end. The real issue is not that chump change of a few billion, but the viability, credence and faith in any and all islamic bonds anyplace, if this one defaults. Over just the last decade, islamic Sukuk issuance from Morocco to Malaysia has approached a trillion dollars. All faith based. None is interest bearing. A collapse of that magnitude would certainly be just as, if not more dramatic, than anything we experienced last year. Fact is that the various financial disasters from Lehman to derivatives, and collapse of real estate pricing, banks and insurance companies in the western world had relatively small effect in  Middle Eastern countries in which Islam was the State religion. The reason for relatively little damage is that the peculiar islamic banking rules have to some measure insulated them from our own much more peculiar, not to say bizarre derivative debacle.

However, it did not protect Dubai from the fallout.

Dubai had gone hog wild with unimaginably expensive and downright silly investments in dream city real estate projects which are now turning out to be the mirage one could see shimmering over the sand dunes all along. The warning signals have been there for years and pointed out by the few commentators that did not have to fear imprisonment since they did not actually live or do business in Dubai.

Time to pay the piper.

The Dubai World and Nakheel Sukuk is by far worse than any garden variety western junk bond. The purpose of this bond was to raise money for some of the most gaudy not to say laughable and absurd projects imaginable. Everyone of these projects started as a “vision” or dream in the mind of its megalomaniac uneducated ruler (Apparently he never finished school). Some projects are now halted in mid construction because there is no fresh money coming in and payments to contractors, workers and suppliers have been halted long ago. The Sukuk repayment to investors has been unilaterally postponed for six months. In fact all Dubai bonds have been suspended from trading before the markets opened Monday 11/30/09. There was no warning. There was no consultation. There is no precedent for this action. The bond is secured by partial ownership in a circus (well, actually Cirque de Soleil which is quite respectable as a public spectacle), an old passenger ship ( actually the respectable but useless nevertheless QE2) and  a long long row of dry as a bone shimmering in the heat bunch of shifting sand dunes (well, actually some of them are on the waterfront, with trash, oil waste and fecal material gently lapping on the beach). This stuff secures about 4 billion. Sort of.

Actually there is no legal recourse to collect by investors. The islamic underlying rule for a Sukuk bond is that investors are partners and therefore must accept the losses since there is no guarantee of profit. Unbelievable as it may sound to western ears, a promise to pay back capital is against islamic rules. Yup, the unbelievers have been left in utter disbelief.

My guess: (Even if Abu Dhabi pays off all of Dubai’s sins), Islamic bonds are toast in the future…

As for Sheikh Mohamed bin Rashid al Maktoum, as ruler of Dubai he is most unlikely to do the perp walk. Although islamic law considers non payment of a debt a crime and Dubai does not have a bankruptcy procedure, a scapegoat has been set up. His name is Aidan Birkett, a partner in Deloitte, who was selected to straighten out the mess, of course under the watchful eye and overruling advice of the sheik. This should be fascinating, because Aidan will most certainly look at this assignment from the perspective of the Basel Accord banking supervision. I see he includes in his resume his recent experience with corporate reconstruction including Iceland (some reconstruction!!) and the fact that he was awarded the “turnaround professional of the year award in 2002.  Frankly I can’t see how he will manage to put lipstick on a swinish bond that has neither interest nor any credit rating whatsoever.

Of course the Sheik will refer Aidan to the Sharia board. Wonder how he will deal with the fact that islamic legal jurisdiction is not bound by either precedent or legal opinion, or codification or interpretation or accounting or auditing standards.

Lack of standardization is not considered a weakness but is interpreted as greater “flexibility” and a strength of islamic finance. Since the old men on the board are religious sages yet have little if any training in modern economics and wear galabeyahs one couldn’t even say that they will fly by the seat of their pants. My guess is that after some consultation with Abu Dhabi, getting that brotherly country to bail him out in whole or part,  the Sheik will say just what he wants and needs and that is what everyone and Adain will rubber-stamp. Or else.

It’s a tempest in a chay pot.

So far.

CARLOS BENEMANN is a California Certified Court Interpreter, a graduate of UC Berkeley and studied economic anthropology in Argentina and Berlin, Germany. He served as an intern projects officer at the United Nations Development Program. He lives in Humboldt County and can be reached at  fernbook@humboldt1.com

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