Dubai World and “Negotiating” the AIG Payouts

Dubai World, which is a state-owned company out of (you guessed it) Dubai, has announced the need to restructure its debt payments creating a lot of uncertainty in markets as to whether this amounts to a sovereign default that should lead people to panic. Willem Buiter says there’s no need to freak out, that this is basically just a real estate company having problems, and Paul Krugman observes that “US bond prices are up right now, suggesting that the Dubai thing hasn’t raised expectations of default.”

It’s worth thinking about this, however, in the context of suggestions from the SIGTARP and others that Timothy Geithner should have driven a harder bargain with AIG’s counterparties rather than paying out the full value of AIG’s debts on credit default swaps. The only way to achieve this would have been for the US government to credibly threaten to default on the debts of a US state-owned company. It looks like the world financial system probably can process the default of a Dubai-owned company without that unduly impairing the ability of major sovereigns to borrow. But still people are clearly at least somewhat nervous. An American default scenario would have posed much bigger risks and would have done so at a period when the whole world looked more vulnerable to shocks.

For what it’s worth, though, Felix Salmon seems to agree with me about the relevant linkages but reaches the opposite conclusion and thinks sovereigns should let state-owned enterprises default on their debts all the time.