Dubai's Dilemma: A Warning To NY

There’s a vital lesson for New York in the travails of Dubai, the little Persian Gulf emirate with big buildings and bigger debts -- if only our politicians and taxpayers would understand.

Last week, Dubai’s state-owned investment arm, Dubai World, told its banks (mostly British) that it needs a freeze on debt repayments. It also needs to cut the $60 billion that it borrowed to speculate on office towers, hotels, luxury retailers and the like.

Global bankers were shocked. The Dubai government doesn’t legally back Dubai World’s debts -- but investors had thought that two levels of bailout would protect them if Dubai World’s projects failed. If the company’s dubious investments ran into trouble, they figured, Dubai would bail them out. And if the Dubai government wouldn’t or couldn’t do so, then Abu Dhabi (the richest of the seven United Arab Emirates) would step in, so as not to make all the emirates look bad.

But now the emirates are reluctant to use finite resources to rescue supposedly sophisticated investors without asking for anything in return.

Pay attention, New York: Albany and New York City have their own “Dubai Worlds” -- state-owned entities that borrow buckets of money to invest in oft-dubious projects without the “official” backing of taxpayers.

New York’s public authorities and other state-related corporations have $150 billion in debt. And some of these entities are smokescreens for boondoggles that taxpayers would never support if they thought they were on the hook.

T

he most recent example is Atlantic Yards, the $4.9 billion basketball arena and luxury-apartment project in Brooklyn. By December, developer Bruce Ratner must raise the arena’s first bonds, $800 million approved by the Empire State Development Corp. The debt supposedly comes without a government guarantee: If revenues from luxury-box sales and such don’t cover the debt, bondholders lose.

But if lenders believed that, Ratner probably couldn’t borrow at a price he could afford for this project -- a luxury stadium for a losing team. Plus, there are no comparable deals that investors can look at to see what they should charge, and no one knows what demand for luxury boxes will be like in half a decade.

So anyone buying Ratner’s bonds is likely counting on Atlantic Yards being “too big to fail.” And Empire State Development Corp. officials play along. “I don’t know if I’d characterize [the state] as willing [to let Atlantic Yards’ bonds default],” ESDC lawyer Jonathan Beyer said last week. “It’s just that the documents do not require us to make any payments.”

Just as with Dubai, lenders think we have our own rich uncle: If Albany can’t bail us out of our boondoggles (and the rest of the state’s profligacy), they figure, then Washington will.

Plus, there’s the Fannie Mae/Freddie Mac precedent. Fannie and Freddie didn’t enjoy official taxpayer backing, but investors for decades assumed they did -- and the feds made good on that assumption last year.

In New York, someone -- taxpayers or bondholders -- could be surprised someday, as Dubai’s lenders were.

Taxpayers and voters don’t realize that their money is on the hook here -- so they don’t force Albany and City Hall to aid the infrastructure projects that create the most growth. Nor do bond holders examine the merits of particular projects: They just figure the government will cover their losses.

Authority and other “off-balance sheet” debt, then, can just grow and grow. Albany is close to enacting a bill to “reform” public authorities by adding oversight from an independent budget office and directing the state comptroller to review their contracts. But those po litical controls don’t address the core problem.

The best antidote for the most questionable spending would be some market discipline: Warn bondholders that they’ll suffer if they put their money in a white-elephant project or in an authority that can’t control its spending.

To that end, Gov. Paterson and Mayor Bloomberg should make it crystal-clear that no New York state or city entity will make up for any shortfall in debt that doesn’t have an official guarantee, even if it means a default. They should even warn the ratings agencies to not consider the possibility of state or city support when grading this debt.

Lenders, too, should be wary, even if the state and city keep coy. As Albany runs out of money, it could pull a Dubai -- telling lenders, after it’s too late, that it’s sticking by the fine print.

This piece originally appeared in New York Post

This piece originally appeared in New York Post