For the past dozen years we have been warning of the extremely dangerous imbalance brought on by the monumental amounts of debt outstanding in the United States relative to the Gross Domestic Product of our country. Many others looked at the data and were similarly alarmed, but most did not let that danger deter them from continuing the investment patterns they had practiced successfully for many years. A few argued that we were unnecessarily concerned, because the debts were not excessive in light of the growth in value of stock and real estate assets.
A great many of those debts are now starting to come due both domestically and internationally. Loans with balloon payments and reset features have already caused havoc in our domestic markets. The Dubai crisis is demonstrating on a grand scale the flawed belief that asset prices go in only one direction. Those of us with decades of seasoning have lived through the cyclicality of both stock and real estate prices. Perhaps each generation has to learn from its own bitter experience.
Until now we have seen a broad willingness of governments and central banks to shore up a large portion of debt that would otherwise fall into default. This week’s sobering news out of the Middle East that there may be no government guarantee behind the debts of Dubai World could, however, signal the onset of an extended period in which debts may have to be evaluated on the creditworthiness of the borrower alone. The danger exists that some of the world’s largest bond portfolios are bearing far more risk than they had earlier believed.
For the past year we have suggested that a great many corporations and municipalities would default on their bonds before this credit crisis is completely unwound. The government’s largesse has rekindled enough investor enthusiasm to permit many deeply indebted entities to roll over debt or recapitalize in the equity market. The Dubai crisis might, however, reduce investor willingness to buy new debt and equity issues.
At this point we can’t know whether or not Dubai is a stand-alone situation. As firm believers in the cockroach theory, however, we suspect that having seen one Dubai, we can be reasonably confident that there are many more lurking in the darkness.
Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.