Dubai’s government has told banks owed money by its major business arm, Dubai World, and its property group, Nakheel, to go jump.

It wasn’t so much an act of defiance, more telling banks the reality of the situation into which they lent money. Dubai World and Nakheel may be government-owned, but they are not government-guaranteed.

And like grown-ups, Dubai World and Nakheel have started restructuring talks with their banks covering $US26 billion of debt, including the $US4 billion Islamic loan due on December 14.

The proposal involves Dubai World and subsidiaries including Nakheel World and Limitless World while excluding units such as Infinity World Holding, Istithmar World and Ports & Free Zone World, “which are on a stable financial footing”, Dubai World said in a statement. The amount includes about $US6 billion of Islamic bonds sold by Nakheel. They are the ones Nakheel halted trading on earlier on the local exchange.

“It is envisaged the restructuring process will be carried out in an equitable way for the overall benefit of all stakeholders,” Dubai World said in the statement, reported on Reuters, Bloomberg and Dow Jones wires.

Of course, there’s a downside for the government and the Royal family that owns Dubai (the Maktoums) in that their grandiose visions for the emirate as a financial centre and entrepot will be dead for a year or three, or until the next generation of eager bankers arrive with no memory and oodles of money and a need for bonus-boosting deals.

The Dubai government said after markets had fallen by about 7% on Monday that it was not responsible for the debts of its flagship conglomerate, and offered nothing much else on last week’s call for a six-month standstill on billions of dollars in debts owed by Dubai World and Nakheel.

The government’s defiant stand came in a TV interview by Dubai’s leading finance official who said:

“Creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct,” said Abdulrahman Saleh, director general of Dubai’s department of finance. He said that banks did not need extra liquidity and that the market reaction to Dubai World’s restructuring had been overblown.

The Dubai World statement came later, but hasn’t been posted on its website.

Indeed, other commentators have pointed out that the 2006 prospectus from Nakheel for a near $US4 billion Islamic bond raising did point out that the offering was not guaranteed by the Dubai government.

The Financial Times blog, FT Alphaville had a post last week with the structure of the Nakheel Islamic loan (called a sukuk). It’s a structure that would not be out of place in Barry Jones’ now-famous Knowledge Nation Spaghetti special of a few years ago. Anyone who leant on something so complicated and claimed to understand it, deserves to lose money.

DB World and Nakheel are private companies whose share capital is owned by the government, which therefore limits the government’s obligations to the capital of the two groups.

The Dubai government could have also reminded banks that they had a duty to “know their customer”; a banking adage that was jettisoned years ago, but again has been made relevant by the rorts and frauds in the subprime markets in the US and other markets (Bernie Madoff, for example).

Nakheel’s move to halt trading on $US5.25 billion of its bonds has trapped investors who couldn’t sell last week because the markets have been closed. That will further annoy the nervous nellies among the banks who believe they should have a free “get-out-of-jail” pass by being paid out by the government.

But if you lend money, you have to be prepared to lose it, no matter who owns the borrower. For years no one thought that Lehman Brothers would go bust, or Fannie Mae or Freddie Mac would be taken over by the federal government, which most investors though already owned them.

In fact some commentators have pointed out parallels between Dubai World, Nakheel and Fannie and Freddie.

The Financial Times assessed the response in these terms in its Lex column:

“The problem is is that global investors see the borrowers’ woes as a microcosm of the emirate’s. The latter’s failure to communicate decisively and promptly with the capital markets on which it relies has dented its chances of becoming a credible financial services hub over the coming decade. Still, the United Arab Emirates central bank’s liquidity support for local and foreign lenders should give regional banks a lifeline for now.”

Dubai is now just an isolated outbreak, but watch Greece for a much bigger blow. There’s lots of talk of the European Commission and ECB refusing a bailout, except on tough terms, and eventually the International Monetary Fund coming to do the dirty work. More losses for banks. Greece needs to roll over and raise close to $US70 billion of loans in 2010. Fat chance. More problems for banks.

Peter Fray

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