Dubai or not Dubai, that is the question

The good news is that the $700 billion financial rescue package has been passed and we now have the spectacle of watching two big banks wrestle to take over another bank. A few weeks ago, the Fed was begging banks to buy their weaker fellows. Granted, Wachovia is no Lehman. But that Citi now feels strong enough to go toe-to-toe with Wells Fargo is a good sign. So is Warren Buffett's investment in Goldman Sachs. A key vote of confidence. Buffett doesn't do anyone favors. The man obviously senses a bargain and just in case he negotiated himself one.   It is for this reason, along with a couple of others, that the dollar is rallying. The US looks sick, but the rest of the world looks like it is about to get a lot sicker. And while the cost of fixing the financial system is doubtless going to rise even higher, at least it is now getting fixed. Moreover, financial instability is less likely to cause political instability in the US than in almost any other country. No matter how bad things get, it's hard to imagine tanks barreling down Pennsylvania Avenue to maintain order. Not so elsewhere. So without any other currencies capable of supplanting it, the dollar is regaining favor among risk-averse investors. What are they buying with those dollars? Not real estate, not stocks, not bonds and not even commodities. It seems cash really is king these days. And given that companies are now unable to get short-term financing from banks, that cash should be in hard currency form.   Make no mistake. The $700 billion rescue was essential to getting the banking system moving again, but it is not and will not be a bailout. Buying up and selling toxic assets will very likely cost the US government much less than $700 billion, but it will hasten the need for banks to consolidate or recapitalize. That may end up costing the government more money. In the meantime, the economy is just getting worse.   The bad news (in case you're now inured to America's travails) is that, as predicted here many times before, Europe is starting to succumb to the Yankee flu. International investors are pulling out with increasing rapidity from emerging markets bar one: China. There the prospect of a government-stimulated economic growth is luring more investment, something China's authorities will have to respond to with a reciprocal outpouring of investment if they want to avoid a rekindled investment bubble and inflation.   More bad news comes from Dubai, where property prices are looking so shaky that government-run DIFC Investments has decided to buy it, attempting to prop up the price of the Emirate's one abundant natural resource, land. Where they'll get the money for this feat is anyone's guess, because Dubai Inc. faces rising borrowing costs on international markets. It seems only a matter of time before Abu Dhabi is presented with a critical question as to whether it needs to bail out Dubai or just come in and buy it at cents on the dollar.   The question for Abu Dhabi will be similar to that the US Congress just faced: is Dubai's financial industry too big to fail? In other words, does the UAE stand to lose more from the insolvency of Dubai's financial institutions than it does from clearing out the excess leverage and having the country's healthier banks buy up the assets at discounts? Abu Dhabi, unlike the US, is flush, so the risk that the country would have to sell off the banks to foreign investors is low. And Abu Dhabi will pay less to buy such distressed assets than it would to recapitalize the banks as they are.   The risk, however, is that if Abu Dhabi does not step in with capital to fund Dubai and its banks, that Dubai will tap its newfound connections in Japan and China, who would love nothing better than to get a piece of the action in the Gulf. The problem for them, of course, is that what they really want is oil, not real estate. So unless buying up Dubai assets somehow brings them closer to crude, Asia's cash-rich governments may not have so much interest in Dubai. Perhaps Russia represents a source of easy financing for Dubai.   Some say the bailout by Abu Dhabi is already underway. The UAE central bank's liquidity facility largely funds Dubai's refinancing needs, they point out, not Abu Dhabi's and therefore represents a bailout by cash-rich Abu Dhabi of cash-strapped Dubai. But I don't believe it's accurate to count the UAE's reserves as Abu Dhabi's. Most Abu Dhabi income gets funneled into the Abu Dhabi Investment Authority, the Abu Dhabi Investment Council, the International Petroleum Investment Company, and Mubadala Development. Until those funds start buying Dubai assets, I wouldn't call it a bailout.