Because so many big-time investors poured money into Dubai World, it naturally became too big to fail. The Dubai panic is for now eased, but it could return at any moment because its cause — the same socialized risk that our own politicians refuse to recognize here — remains.
Dubai’s state-owned investment company suffered massive losses in the global financial meltdown. Investors panicked when the firm announced last week that it needed to postpone debt payments for six months.
The panic was understandable: Before last week, Dubai World looked like a sure thing because everyone figured it would recoup losses with a bailout from the Dubai government, or that of nearby oil-rich Abu Dhabi. Such thinking allowed the company to take on $60 billion in debt (a low estimate, according to some economists). Dubai World’s failure could have become the biggest emerging-market default since 2001 in Argentina (where tanks rolled in the streets at one point).
Markets only started to stabilize once the Middle Eastern firm announced it only needed to postpone payment on half its debt, and the United Arab Emirates’ central bank provided new liquidity. Another economic crisis was thus averted — for now — but Dubai World 2009 was a close relative of the American housing market disaster of 2008.
Here, the U.S. government encouraged lenders to loosen standards to provide mortgages to unqualified borrowers, with implicit guarantees of government bailouts in the event of difficulties. When the inevitable crisis came, the U.S. economy virtually ground to a halt and continues to struggle even today.
But politicians such as President Barack Obama and Treasury Secretary Tim Geithner point to “predatory lending” as a prime cause of the financial crisis. This explanation is undermined by an inconvenient fact: Two-thirds of the 26 million subprime or other nonprime mortgages came from the Federal Housing Authority, Fannie Mae and Freddie Mac, and the four largest U.S. banks.
As Peter Wallison of the American Enterprise Institute wrote, “The fact that the government itself either bought these bad loans or required them to be made shows that the most plausible explanation for the large number of subprime loans in our economy is not a lack of regulation at the mortgage origination level, but government-created demand for these loans.”
When government replaces free market supply and demand with bureaucratic fiat, politically influential firms inevitably become “too big to fail” and require bailouts when things go bad. Now, Obama and Democratic congressional leaders propose more interference, from small-business bailouts to another new federal consumer “protection” agency.
Will our politicians ever learn that free markets driven by customer demand provide more widespread prosperity and less economic tumult than government edicts, guarantees and five-year plans?