The Dubai government refused to guarantee the huge debts built up by its conglomerate Dubai World, dashing investor hopes that the latest episode in the global financial crisis might be swiftly resolved.
In an interview on local television, the director general of Dubai's department of finance, Abdulrahman al-Saleh, appeared to suggest that investors only had themselves to blame for the unfolding crisis. "Creditors need to take part of the responsibility for their decision to lend to the companies," he said.
"They think Dubai World is part of the government, which is not correct. Dubai World was established as an independent company; it is true that the government is the owner, but given that the company has various activities and is exposed to various types of risks, the decision, since its establishment, has been that the company is not guaranteed by the [Dubai] government."
Moral hazard describes the phenomena where a party that is insulated from risk behaves differently from the way it would behave if it were fully exposed to that risk.
It is very easy to see in this case that the limited liability status of Dubai World — an entity created and owned by the Dubai government, presumably (although I have not checked this) registered under Dubai law that the Dubai government created — means that the Dubai government can deny responsibility for the risks that it created Dubai World to assume in pursuit of its own economic strategy for which it now denies responsibility. A better example of moral hazard is hard to imagine.
Unless, of course, we consider the case of banks in the UK and elsewhere that also trade with limited liability but in their case with the implicit unlimited guarantee of the taxpayer to back them, creating another form of moral hazard.
In both cases the moral hazard has, of course, been created by a form of asymmetric information: Dubai World knew the risks it was taking and the fact it could not enjoy a state guarantee. those who lent appear (as is the way of the market — so ill informed is it) to have been unaware of the risks they were taking and assumed there was an implicit guarantee.
I am not suggesting as a consequence that we should get rid of limited liability entities: as a matter of fact I suspect that near enough impossible to do, although I know some argue for it.
I am arguing that if we are to have limited liability then there is a special duty of care imposed on those who take advantage of it, which no one is obliged to do. That duty of care is to provide considerable information concerning the beneficial ownership, true nature of management and financial performance of each and every limited liability entity that exists — anywhere in the world and for whatever purpose it is used. The argument is simply that without this information, including country-by-country reporting. those who engage with a limited liability entity are, without exception, the potential victim of moral hazard of the form now being suffered by the creditors of Dubai World.
That is not acceptable: if markets are to be effective, if unjust enrichment and straightforward fraud is to be avoided, if risk is to be allocated appropriately then the price of limited liability is transparency.
Secrecy jurisdictions promote secrecy: they promote moral hazard, risk, distorted markets, unjust enrichment, fraud and more besides as a consequence.
That is why secrecy jurisdiction undermine the effective operation of all markets.
And opacity undermines markets in exactly the same way.
You cannot support markets and support either opacity or secrecy jurisdictions: they are incompatible.
Dubai should teach us an expensive lesson. It is time it was learned and action taken.
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“Unless, of course, we consider the case of banks in the UK and elsewhere that also trade with limited liability but in their case with the implicit unlimited guarantee of the taxpayer to back them, creating another form of moral hazard”
hmmm – the UK government chose to step in and “save” its failing banks. There was no particular reason before the event to suppose it would, and certainly no guarantee, which I guess is why we had the headline pictures of savers queuing outside branches of the Northern Rock when the news broke – even after the Government stepped in.
Alastair
This really is not very honest of you
The BoE was lender of last resort and had clearly stepped in to make sure no depositor ever lost in a UK bank
I’d go so far as to say you’re just wilfully misstating the case – not least because guarantees (albeit not unlimited) were in place
Richard
Oh come on Richard – Lender of Last Resort is not the same as “Government acts as underwriter for all UK Banks for all liabilities for all time”. The Bank has always had the mantle of Lender of Last Resort, and it funds it by way of Levies and Guarantees from the Banks regulated in this Country. There never was a Government guarantee – the only buffer for savers was the £50K guarantee, or whatever it is at the moment – and that is also underwritten by the banks. What actually happened was Brownian Politics, but you can’t always rely on that.
Surely what happenned is that the banks had the government over a barrel. “Rescue us or the whole economy and finanacial system will collapse”. Any primeminister of any party would, at that point, have had no choice but to act as Brown did. The “choices”, to allow banks to gamble the economy were made earlier and clearly wrongly.
There was no written guarantee except the knowledge that the government could not allow the country to collapse.
In other words, Alastair, I don’t think you understand what took place and what the potential consequences of government inaction were.
@James from Durham
Agreed
@James from Durham
of course nobody knows what the consequences of government inaction would have been – we can only know what happened. But if you think that is a guarantee then you are the one who is not understanding
Alastair
Just imagine what would have happened if no cash had come out of RBS and HBOS cash points
If all other clearers had not been paid by them – to the tune of £62 bn
You are being wilfully stupid Alistair
I presume you are seeking a ban from this site
I’m happy to oblige, because I really do not have time to waste on such pedantry
Richard