This speech was presented on October 25 to the University of San Diego Law School by Robert P. Smith:

Bill has been in the belly of the Russian bear and lived to tell about it. I knew a journalist who was murdered for doing things less provocative of the Russian business establishment than Bill has done. Allow me to express my great admiration for his courage!

What is my business? I buy, trade and invest in bonds and trade obligations issued by some of the most risky countries in the world. Countries like Zambia, Nigeria, Iraq, Bolivia, and El Salvador and of course Russia.

In my book, “Riches Among the Ruins: Adventures in the Dark Corners of the Global Economy”, I describe how in the late 1970s I was working as an attorney in Boston trying to collect international claims to support my growing family. I was highly motivated to find something more rewarding than collecting corporate receivables. This is how I stumbled into the sovereign debt trading business, which was then a tiny niche business. I was able to use my legal education to make a career very different from that of my law school classmates. Perhaps those of you who are students will also come across such an opportunity to take your legal training in a novel direction.

In the 1970s, before the advent of an active market for emerging market debt, my business required a lot of travel to exotic locations and a lot of shoe leather as I made the business and government contacts needed to buy and sell the bonds of governments in the developing world. In the early days, this was a very esoteric financial niche and trades totaled less than $100 million per year. Today, it’s a $9.2 trillion dollar a year business conducted at computer terminals in brokerage firms from New York to Nairobi, most of it in local currency.

The principal point of my talk today is that lending to countries, either directly or through the purchase of their debt instruments, is becoming riskier due to the convergence of a number of factors
.
These factors include:
- the securitization of emerging market debt
- the advent of bond funds as holders of EM debt
- the unprecedented demand for bonds due to:
- easy money,
- baby boomer demand for bonds and, more recently,
- fear of the stock market’s volatility
- the rise of highly skilled legal representation of defaulting countries
- the emergence of the recalcitrant debtors: Argentina & Russia,
and
the inclusion of collective action clauses in debt documentation

Let’s look at each of these in turn.

(1) First, securitization.

Perhaps the most important factor that has contributed to the erosion of the position of creditors has been the trend towards securitization of debt. This is not so much securitization in the form of complex structures like those we saw in the subprime crisis, although they have shown up in emerging market debt as well, but the mere fact of countries borrowing by issuing bonds (securities), rather than borrowing from banks.

Back in the 1970s the only people willing to lend to emerging market countries were the commercial banks which formed loan syndicates led by the large American institutions, the money-center banks as they were then called. When countries got into trouble these big players were able to present a united front in dealing with the distressed debtor. The borrowing countries needed the banks for trade credit lines and other types of financing so they had a lot of incentive to maintain good relations with the banks by repaying their loans on time This made the negotiations between the banks and the borrowing countries mostly collegial.

Now, with sovereign debt principally in the form of bonds as opposed to syndicated loans, the creditors are a widely dispersed group of institutions and individuals so it is much harder for creditors to find leverage or to act in concert to force repayment when things get dicey. Believe me, a half dozen big banks such as Citibank and J.P. Morgan have a lot more leverage than a thousand dentists in Beligium or Italy who are holding Russian bonds! So, my first point to you is that the mere shift from bank loans to the securitization of sovereign debt as the principal means by which countries borrow money has had a profound impact on the risks associated with being a creditor to a foreign country, especially those in the emerging markets.

(2) The second factor that has changed this market is the rise of the Bond Funds.

The largest holders of sovereign debt are now the bond funds, not the banks. You might think that these funds, often managed by large financial firms would, like banks, have a lot of leverage, but it’s not the case. Why? Because the way funds deal with troubled borrowers is very different from the way banks deal with them. If a borrower is showing signs of distress, banks take steps to “work-out” the troubled credit in their portfolio. They may use covenants to push the borrower in the direction of more sustainable operation or organize a restructuring of the debt with other creditors. The bond funds, however, take a much more detached approach to a troubled borrower: they simply sell their holdings of such bonds. They kick the can down the road so to speak.

Why?

Because these funds are required to value their holdings at market prices. So, when the value of a particular bond heads south, it’s immediately reflected in the NAV (net asset value) of the fund. Unless the fund manager has good reason to believe the price will bounce back, it’s easy to just sell the asset. He or she doesn’t enter into workout discussions with the issuing country. Unlike the banks, the funds have no relationship to protect. They’re just buying and selling.

Think of it this way: the banks were married to their borrowers. The fund managers are just dating. Banks, therefore, have incentives to hold on to the weakening credits and try to work them out because they have much more leeway than funds in marking their portfolios to current market prices, and thus can pretend that the weakening of the credit has not reduced the value of their portfolios. Marking to market, as this process of valuing the portfolio at market prices is called, makes bond funds unlikely to get involved in the painstaking, and frequently rewarding, process of working out their bad credits, for which the funds are not properly staffed. If a fund fails to sell a deteriorating credit ahead of a default, it will be tempted to take whatever terms the debtor offers in a restructuring as happened with the highly unfavorable terms accepted back in 2005 by most fund holders of Argentine defaulted debt.
The rise of the individual bond investor and the bond funds as holders of sovereign debt and the inability of these investors to put effective pressure on defaulting borrowers created a niche for funds specializing in buying the defaulted debt of countries. These funds, dubbed vulture funds by their detractors, do the essential work of holding irresponsible sovereign borrowers to account. These unsung heroes include Kenneth Dart and Elliott Management, along with a few smaller groups. My company, Turan Corporation, has participated in some of these transactions.

To paraphrase Frank Borman, astronaut and airline CEO, in his quote about bankruptcy and capitalism, a bond market without vulture funds, is like Christianity without hell. The vulture funds cut though all the rationalizations defaulting countries have for their situation by seeking creative ways under the law to receive payment for the debt they acquire. They provide the incentive for wavering debtors to service their debt or to restructure it responsibly with the consent of the creditors.

(3) The third factor increasing the risk of investing in sovereign debt is Easy Money.
Easy money, in the form of low interest rates and high availability of credit, makes lenders irrational.
When there is a lot of cash lying around to be lent it makes lenders fight with each other over marginal borrowers. Low interest rates make even dodgy borrowers seem like plausible credits.

Can you figure out why large banks would lend to Zambia, Tanzania, Nicaragua, Bolivia, etc? Back in the 1970s big American banks were awash in cash deposited by the oil-exporting countries that were reaping the benefits of much higher oil prices. Interest rates were relatively low. This combination was the principal catalyst in causing the banks to lend with abandon to countries with very spotty histories of repaying their debt. The banks spent the 1980s regretting and working out their folly.

The current monetary policy of near zero short-term interest rates makes bond investors look for returns in all the wrong places.

Some have crept out further on the yield curve by accepting longer maturities in order to achieve higher yields. The best example is the buyers of a one hundred year bond with a fixed 5.75% coupon issued by Mexico. Fixed coupon bonds get ravaged by inflation. Consider that the US dollar has lost over 86% of its value to inflation since John F. Kennedy was elected president 50 years ago. Imagine how much value this bond could lose in a hundred years?
Other bond buyers venture out to local currency obligations, such as Peru’s 27 year bonds recently issued at 6.9% in new sols, a currency whose predecessor was wiped out by hyperinflation.

We are witnessing again the stupefying effect of high liquidity and low interest rates on lenders.
Easy money interacts with other factors to make creditors even more prone to bad decisions. The aging of baby boomers and the volatility we have witnessed in the stock market in the past years have led large numbers of investors to avoid stocks and to buy bonds, which are supposedly safer.

Since the supposedly safe 10 year US Treasury now yields an investor only 2.36%, our yield hungry boomer investor will look for the Russian 10 year bond which yields an extravagant 4.37%.

Talking about seeing investing mirages on the Russian steppe, let me share a story from my book, “Riches Among the Ruins”. In June of 1998, during the era of irrational exuberance and easy money, I was invited, along with a large group of Western investors, on what I came to call my “Magical Mystery Tour” of Russia. The trip was sponsored by one of the most dynamic of Russian banks, MFK Renaissance. I was impressed by Russia’s immensity (it spans ten time zones) its vast mineral and oil wealth, and its educated population. This Russia of vast potential was also the Russia with a large overhang of short-term local currency debt it had to keep rolling over all the time with foreign investors. Never in my wildest dreams did I think the world would let Russia, a country with a vast nuclear arsenal, default. Russia was too nuclear, too unpredictable. The whole world would rescue them; the IMF, the US the European Community. Everyone wanted this experiment of transition from command economy to market economy to succeed. Russia was too big too fail. As soon as I got home from my trip, I invested another $ 5 million on top of the $ 15 million of Russian I had already bought prior to my trip.

A couple of months later, on August 17, 1998, Russia began to default on most of its debt and devalued the ruble. Overnight the value of my personal holdings of Russian bonds plummeted by $15 million dollars. It was not one of my better days.

The day before the default, a close friend had asked me for investment advice, and I had told him to buy Russian bonds— Russia is too big to fail. We are still friends but he doesn’t ask me for my investment advice anymore. Too big to fail, we have all seen this recently in the United States: General Motors, Chrysler, AIG, Fannie Mae, Freddie Mac.
This story should remind us that all the sovereign lending now being made under the influence of high liquidity and low interest rates will some day prove very hard to collect, even for the so-called vulture funds.

(4) Another factor contributing to the risk for investors in sovereign debt is the emergence of highly skilled legal representation of defaulting countries.

Certain major law firms have taken up the defense of defaulting countries such as Russia and Argentina and have made a significant difference in eroding the ability of creditors to secure judgments against defaulting countries and to enforce judgments.

(5) Now let’s move to the so-called Recalcitrant Debtors: Russia & Argentina.

Russia inherited most of its foreign debt from the Soviet Union, although all of the local currency debt at the core of its 1998 default was incurred by the new Russia. One creditor of the Soviet Union, a Swiss company named Noga, made ingenious attempts to attach assets of the Russian government ranging from enriched uranium held at a facility in Paducah, Kentucky, to the tall ship Sedov, to the jet fighters that might have attended the Farnborough Air Show in England.
Along the way, these attempts resulted in legal precedents that significantly moved courts in the US away from holding central banks of countries responsible for their commercial actions.

Russia broke new ground in dodging creditors by creating a private entity where it could hide its reserves in off-shore accounts out of the reach of creditors. This highly unorthodox scheme was audited by PriceWaterhouse, and blessed by the IMF, creating another bad precedent for dubious behavior by sovereign debtors.

Russia, now an investment grade bond issuer, was warmly received in its return to the Eurobond market this year. The bond market, made irrational by walls of investor money seeking yield, has conveniently forgotten how poorly Russia treated its bank lenders, trade creditors, and bond holders. Russia used a brief drop in oil prices during 1998 to extract deep concessions from its bank creditors, that resulted in much Soviet-era debt being reduced by about 37%. Despite the fact that oil prices tripled the next year, Russia held its creditors to their concessions ignoring its vastly improved financial situation, and restructured its debt in early 2000.

Trade creditors of the Soviet Union were forced into this same deal, but had to wait years for Russia to actually keep its part of the bargain. They were put at the mercy of the Russian bureaucracy supposedly to “reconcile” the amounts owed. The process of “reconciling” the trade debt took nearly a decade after the bank deal of 2000 to arrive at some type of conclusion, but there are still trade claims pending.

We had the strange experience of being called about claims we had presented to entities of the Russian government by private parties seeking to buy them. The interested buyers had details about the claims that could only have come from Russian official sources.

War ravaged Iraq, by comparison, managed to reconcile all its trade claims in a matter of months. Yet, the bond market views Russia as a fine credit.

Argentina’s default in 2000/2001 broke a record for size, nearly 100 billion US dollars. Argentina also stands out as a naughty debtor for having defaulted on debt to the World Bank, a concessional lender nobody in his right mind would default on. After its $ 100 billion default, Argentina let creditors wait until 2005 and then presented them with a highly coercive deal worth somewhere around 25 cents on the dollar. It told creditors, participate or your debt will be worth nothing because our legislature has passed a law forbidding any deal with creditors who do not participate in this one. 76% of creditors accepted the exchange in 2005.

Some of the outraged holdouts from 2005 took legal action against Argentina in US federal court. The court issued numerous judgments against Argentina. However, the judgments awarded to Argentina’s long-suffering lenders have proven nearly impossible to enforce. The country has, using the advice of its sophisticated attorneys, hidden its assets in places not accessible to creditors. The tacit cooperation of international entities such as the Bank for International Settlements (the central bank for central banks) with Argentina has also made recoveries difficult.

Hoping to get into the good graces of the international bond market, Argentina, in 2010, made another offer to exchange its defaulted debt under terms equivalent to the 2005 exchange. The latest exchange was accepted by 66% of the holdouts. Many of the remaining holdouts continue to press their legal cases.

It should not surprise you to hear that Argentina, despite having terribly mistreated its creditors, hopes to return to international bond markets in the near future; it should surprise you even less that the bond market, desperately seeking yields, would welcome it back.

Finally, let’s spend just a moment on Collective Action Clauses.

These are provisions in bond indentures or loan agreements that allow a supermajority of creditors, say 75%, to force a restructuring on dissenting creditors. Such clauses make it impossible for holdout creditors to seek a separate deal with the borrower.

Collective action clauses make it much easier to reach a restructuring deal with the defaulting borrower. The borrower needs to offer a deal good enough to satisfy only a supermajority of holders to protect itself from the threat of litigation. The result, typically, are restructurings that are, on the whole, more favorable to borrowers.
These clauses are thought to create a moral hazard by tempting weaker borrowers to default, safe in the knowledge that they will be able to cut a nice deal with the apathetic majority of creditors and not have to bother with the troublesome minority. So, if you invest in sovereign debt, beware the collective action clause!
In closing, I want to remind you that the weakening of the ability of creditors to enforce their claims is rarely an issue in good times, but when the bad times come and borrowers like Argentina or Russia decide to deal unfairly with its creditors, all bets are off.

The economic and political ties between Iran and China are often brought up in the context of geopolitical negotiations, with China’s oil purchases leading the headlines. That’s understandable, given Iran’s importance in the Middle East. Overlooked, however, is another country that is even more important to China’s oil supplies – Angola.

Angola sent 235 million barrels of oil to China last year, or about 640,000 barrels per day. That’s 66 million barrels more than Iran, and only a bit less than the largest supplier, Saudi Arabia. In fact, Angola eclipsed Saudi Arabia as China’s top supplier last month, although that may change as the year goes on. According to Royal Dutch Shell, Angola will produce double the amount that Nigeria does within 10 years – though that prediction hinges as much on Nigerian instability as it does on Angolan development.

Angola emerged from a bloody war of liberation against Portugal and a prolonged struggle between Marxist and anti-Communist factions. Its diamond mines and oil reserves promised both future prosperity and foreign interest or even meddling in its affairs. Though it’s been the fastest-growing economy in Africa with double digit growth from 2006-2008, it’s also plagued by rampant corruption, separatist guerrillas, and millions of landmines. Formerly an agrarian economy and exporter of agricultural products, the countryside was so thoroughly devastated by war that it now imports 90% of its food.

As it exports more oil and discovers more fields, Angola will grow in importance on the global stage. It’s also an important front in the Chinese effort to secure African assets and allies, as China’s largest trade partner on the continent. Estimates of Chinese loans to Angola vary wildly, from $2 billion (the official figure) to as much as $9 billion with confidential, behind-the-scenes loans.

Angola illustrates the complex interplay of sovereign debt, resource extraction, and competing national and extra-national interests in the new global marketplace. Angola has about $19bn in public debt, and recently made amends with the IMF after walking away from the fund in 2007. Its rising oil revenues and strong Chinese financing gave it flexibility in negotiating the terms of its obligations that other African nations do not have.

However, Angola isn’t placing all its chips on China. It is seeking to raise as much as $4bn by issuing debt, its first international debt sale. In order to do so, it must get a credit rating from the big agencies like Moody’s, Standard & Poor’s and Fitch. Obviously, either Chinese lending is insufficient to cover Angola’s needs, or it wants to keep its options and obligations diversified throughout the globe.

Investor sentiment is ambiguous, with analysts predicting that nervousness over sovereign debt will mean that Angola only gets about a quarter of the funding it’s looking for. Nevertheless, there does appear to be demand for sovereign bonds from Africa, according to PIMCO, the world’s largest bond fund.

This might make Angola’s auction an opportunity for emerging market debt investors, though – Angola may be forced to offer more attractive yields to buyers made shy by default scares in Dubai and Greece.  Yields will certainly have to be high given Angola’s history of default, as well as the intractable issue of corruption.

In Transparency International’s Corruption Perception Index for 2009, Angola ranked 162 out of 180, tied with Venezuela and the Congo, among others. In this climate, Chinese firms – which aren’t saddled with inconvenient Western laws about bribery and graft in foreign nations – have a distinct advantage.

On the political front, President Jose Eduardo dos Santos has ruled the country since 1979, and appears to basically be President-for-life. Presidency-for-life hasn’t worked particularly well in oil-rich Venezuela. Furthermore, separatists continue to struggle for the independence of the exclave of Cabinda, a small region separated by a sliver of Congolese territory which produces more than half of Angola’s oil. The rebels hit headlines this January in a recent attack that left several members of the visiting Togolese soccer team dead. A violent flare-up in the region could cripple Angolan exports, with most of the offshore reserves located in this volatile region.

The violence in Cabinda is eclipsed by the chaos in Nigeria’s Delta State, where government troops, oil companies, and their workers are in a state of constant tension and sometimes all-out warfare with rebel groups and separatists. Compared to this conflict, Angola’s is relatively subdued.

Many questions still remain regarding Angola’s ability to service its debt, given its past and corruption. It was in default for years, a fact that bond buyers with short memories are likely to ignore. Having invested in Angolan debt before, I know how important willingness to pay is; different countries have different national characters, and they do not just change overnight.

Some of  the incentives to invest in Angola are there,– a reasonable debt-to-GDP ratio of 16.8%, large oil fields with a high rate of new discoveries, and economic ties to the world’s two biggest economies. The question is whether these facts will be enough to sway investors nervous about the future of sovereign bonds in general and Angolan creditworthiness in particular. In the end, the appeal of an Angolan bond offering will depend on a number of key factors – the credit rating they receive from the major agencies, the state of the global sovereign bond market when the government goes to auction, and the geopolitical stability of the nation and its neighbors.

Robert P. Smith, is the founder of the Boston-based Turan Corp., an investment firm specializing in emerging-market debt, and the author of “Riches Among the Ruins: Adventures in the Dark Corners of the Global Economy.”

Farah Stockman wrote a terrific article about Turan, Iraqi bonds, and the way bond prices track political and social stability in conflicted nations like Iraq:

WASHINGTON — Some count the kidnappings. Others count the suicide bombs. Still others count the deaths of US soldiers. But, in the saga of Iraq’s slow struggle toward normalcy, Robert Smith keeps track of something far more obscure: the price of Iraqi governmentissued bonds.

Smith, one of Boston’s most intrepid investors, has made his fortune betting on the world’s most dangerous places. Dubbed the “Indiana Jones of International Finance,’’ Smith buys IOUs from governments so unstable that few others will touch them.

From an office that overlooks Boston Harbor, Smith can recall when Iraq looked like a terrible gamble, as sectarian violence raged and the country slid toward a civil war. But now, a week after Iraq’s historic election, his bets are paying off: The price of Iraqi bonds has doubled in the last year, recently hitting their highest value ever.

“Iraq has the potential to vault past other countries’’ to become a top oil producer, said Smith, a 70-year-old debt merchant whose recent book, “Riches Among the Ruins,’’ details his investment adventures.

Check it out online or in the Sunday Boston Globe.

Latin Finance turned to Turan Corporation’s experience and the Riches Among the Ruins blog for analysis on the struggle between Lulismo and Chavismo in Latin America.

Brazil’s election is looming, with the electorate divided between Lula’s hand-picked successor Dilma Roussef and the Sao Paulo state governor, Jose Serra.

My latest op-ed for the Providence Journal is now available online. I discuss the crisis in Greece and the lessons it holds for the United States.

Read it online at Projo.com, and join the discussion there!

International headlines have recently focused on Greece, one of the 16 countries in the European Union whose currency is the euro.

Greece is in danger of defaulting on its national debt. The reasons are obvious: too much spending and not enough tax collection. The Greek budget deficit reaches 12.7 percent of its gross domestic product and its national debt represents 113 percent of GDP. These numbers are worryingly similar to our own balance sheet, with debt equal to 73 percent of our GDP (but growing fast) and budget deficits at 10.6 percent.

Greece’s potential default has sent shockwaves through global bond and stock markets, which could end up equaling or even dwarfing our subprime housing and banking crisis. As a result, the U.S. dollar has strengthened against the euro and the interest buyers demand on Greek bonds has gone up. A few other E.U. countries, perhaps most notably Spain and Portugal, are also in trouble because of their uncontrolled borrowing and spending.

Read more…

A few days ago, Venezuelan president Hugo Chavez devalued the bolivar. This comes as no surprise. As I wrote in this space in November,

Buffeted by the fall in oil prices and high inflation, there are signs that the Venezuelan economy, and with it Chavez himself, is almost certainly going to implode. He may be able to buy time with various measures to stabilize his currency (the bolivar), such as the sale of dollar-denominated bonds to those willing to risk the investment, but the long-term outlook for the economy is dim…

Inflation is the highest in Western hemisphere, officially around 30%, but likely higher. All this drives demand for a more stable currency such as the dollar. The recent issuance of dollar-denominated Venezuelan bonds, purchasable in bolivars, is intended to soak up the demand for dollars and allow the purchaser to obtain a rate somewhere between the official and the parallel market rate. The big question, of course, is whether Venezuela can make good on the promise…

This weekend, Chavez devalued the bolivar right on cue, sending the people of Venezuela scrambling to buy goods which will spike in price once the measures take effect. The country actually has two exchange rates now – one of 4.3 bolivars/dollar, close to current black market rates, and the other subsidized at 2.6/dollar. The second rate applies to a few classes of goods deemed necessary for the country, including heavy industrial equipment, food and medicine, reported Reuters.

As usual, this will create privileged class of well-connected cronies who snag contracts to buy at 2.6 and sell at 4.3. This has been a recurring problem with the current CADIVI (the government office which controls foreign exchange policy in Venezuela) regime, and it remains a serious criticism of Venezuela’s tightly managed currency regime. Dual exchange rates have a long and ignominious history in Latin America, from Mexico to Argentina. Indeed, Venezuela used to have a body called RECADI in the 1990′s, which established preferential exchange rates to strengthen certain sectors of the economy. As the black market adjusts to the new system and people strive to take advantage of the difference in rates, Chavez will find that the dual rate is not a sustainable system.

The move will benefit certain politically and economically vital industries, said several Venezuelan officials. State oil company PDVSA will get relief from stagnant oil prices, as each barrel of oil sold in dollars yields more local currency with which to pay many of its outstanding debts. Export industries like coffee will find their competitiveness increasing as Venezuelan exports become cheaper.

Chavez’s popularity may take a hit as prices rise. Indeed, the president has threatened to deploy the army in order to shut down and seize the stocks of speculators seeking to take advantage of price differences and shortages, according to the Financial Times. “Go ahead and speculate if you want, but we will take your business away and give it to the workers, to the people,” the British financial paper quoted him as saying.

At this time last year, Chavez did not even acknowledge the existence of a parallel market in the bolivar. For him to now create a dual-rate exchange scheme set near the level of that same black market deals a serious blow to the regime’s credibility and confidence.

Control of his planned economy is slipping through Chavez’s fingers. Eventually, he may realize that trying to strangle private enterprise and market forces will simply delay the inevitable. Hopefully, that realization comes before the country suffers too much more, as Venezuela faces a long and painful road back to economic health no matter what it does.

Dubai did its best to drop the bad news into the Bermuda Triangle of reporting – just hours before markets closed for Thanksgiving and the day before the beginning of the Islamic holiday Eid al-Adha. Dubai World, the investment vehicle and holding company owned by the government of Dubai, asked all of its creditors for an extension on debt issued by Dubai World and Nakheel, its real estate subsidiary.

Dubai World is inextricably tied to the government of Dubai; everything from ports to investment to real estate in Dubai falls under the umbrella of DW and its 90 subsidiaries. Sheikh Mohammed al-Maktoum established the company by decree in 2006 and remains the majority stakeholder in the privately-owned company. Obviously, the corporation falls under the category of “too big to fail,” notwithstanding bureaucratic protestations of the company’s independence from the government.

I’ve seen too big to fail before – I thought the same of Russia in 1998, and I paid the price accordingly. More recently, the United States government declared everything from AIG to General Motors too big to fail. If the US can’t let an ailing automaker sink in a recession, it’s difficult to believe that Dubai would let its flagship enterprise implode. Almost exactly a month ago, I wrote about Dubai’s excessive leverage and the foundation of debt on which it was built. Once again, secrecy is a major problem here. The government sends mixed signals on the degree of backing it will provide for DW – one day lending the Dubai banking system money, the next eschewing responsibility. There are many in Abu Dhabi, whose money comes mostly from petroleum and its derivatives, who would not mind seeing Dubai’s speculative excesses humbled. But the prosperity and reputation of the Emirates is inextricable from that of its most famous member.

Dubai’s biggest problem is simple – it is standing at the edge of a long, unsteady beam overlooking a precipice, and there is an increasingly small amount of real money at the other end holding it steady. There is nothing in Dubai that does not require a constant inflow of liquidity to maintain it; the ventilation systems of its high-rises regularly clog with sand, the city needs armies of underpaid laborers to keep it running, and many of the most ambitious developments, like “The World” and the Palm Jumeirah, are finding that building on artificial islands of sand was perhaps less secure than they had imagined. In many ways, Dubai’s physical reality reflects its fiscal condition – supported with more ambition than common sense.

The consequences of DW’s financial woes will echo into many corners of the world, from subcontinental slums to the marbled halls of European and British banks. India alone estimates that almost 340,000 migrant workers received employment in Dubai and all Indian workers in the city-state sent back $43.5 billion in remittances last year. Conditions are infamously atrocious in Emirate construction companies; many workers have had their passports confiscated, been forced to live in squalid compounds and received far less pay than promised. The article above details how one crew was fired by text message while travelling home for the Eid al-Adha holiday.

On the other side of the scale, Credit Suisse estimates that perhaps half of Dubai’s $80 billion in debt is held by European banks, with Standard Chartered and HSBC the most exposed. These holdings probably won’t be wiped out – Abu Dhabi may let its neighbor take a few hits around the face, but they won’t tolerate a knockout blow. Witness the government’s statement that it would bail out Dubai’s commitments  ”on a case-by-case basis.”

Dubai World’s website still sports the fate-tempting slogan “The Sun Never Sets on Dubai World.” Unfortunately, as history teaches, the sun did set on the British Empire.

Forbes.com ran an article written by me today, discussing the potential for a bubble in sovereign debt, particularly that of emerging market countries.

When I started trading emerging market sovereign debt in the early 1980s, the big risk was non-payment. The danger of default always loomed over a deal. It was like buying a Japanese car or a transistor radio made in Taiwan in the early 1970s: cheap, substandard goods that would likely fail early and often. However, some countries we still label “emerging markets” have become economic powerhouses: China, India, Brazil and Russia for example, holding foreign exchange reserves respectively of $2,300 billion, $284 billion, $235 billion and $433 billion.

Today, more than $5 billion of emerging market debt (EMD) is traded daily and prices are sky high in both debt and equities. Since Jan. 1, 2009 the MSCI Total Return Emerging Markets Index is up 65.1%, outperforming the S&P 500 Total Return Index, which is up 17%.

Read on…

MarketFolly.com also featured my overview of the EMD market.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aVD2G_.A8UEc

Saleh and Turan are mentioned here based on our involvement with Russian debt in the past:

“A lot of debtors in 1998 said they’d never touch Russia again, but memory in the bond market is short, so they are all lining up,” said Saleh Daher, the managing director of Boston- based Turan Corp., which owns Russian debt dating back to the Soviet era. “There is a wall of cash looking for investment, in particular in the emerging-market bond world.”

We learned an expensive and painful lesson in 1998 about “too big to fail.” It’s interesting to see how quickly the ocean of liquidity can make people forget.

This op-ed of mine was recently published in the Providence Journal:

For nearly 30 years, I’ve made my living identifying golden opportunities to invest in the bonds and other debt instruments of such developing world countries as El Salvador, Nigeria, Turkey and Zambia. I’ve never relied on sophisticated economic analyses or spread sheets; I’ve been a gut player relying on intelligence gathered by walking the streets of those countries and talking to bankers, businessmen, government officials and even taxi drivers.

If they had bonds to sell, which they don’t, at least not yet, I’d be lining up to buy bonds issued by the Palestine Monetary Authority (PMA), which, though it doesn’t have its own currency, is the Palestinian central bank.

Why would I buy their bonds? There is something of a slow economic miracle unfolding in the West Bank…

Read the rest here.