There was an interesting article today on Coindesk.com stating that "moulding Bitcoin into the current regulatory framework simply won’t work". The author, a freelance opinion and news writer is obviously a fan of deregulation and definitely not a big proponent of governments and government oversight.

Thinking that virtual currencies are so revolutionary that governments and regulators simply don't understand the concept might be counterproductive. It is at least a dangerous underestimation of the traditional financial industry and the institutions that regulate it.

It is true that no-one needs a third party to send and receive Bitcoin. You don't need identification or even an email address. Criminals have been using a form of payment that has exactly these properties for centuries. It is known as cash (or "fiat currency" for Bitcoin enthusiasts). Of course there are a great number of rules that regulate dealing in cash. Try to pay for your condo or jewelry in cash and in most countries there will be a report going out to the local financial intelligence unit. There will always be an interest in the seedy side of anything new. The best proof of success of a new technology is if someone comes up with an illegal way to use it.

Should we therefore just give up on controls and regulations of Bitcoin? The writer states "Regulatory bodies can’t fit bitcoin into current regulatory framework. The two are simply not compatible, and that has nothing to do with any libertarian sentiments in the community. It’s fact." I would very much like to know how this "fact" was established. Even if it is a fact, it is most probably Bitcoin that needs to change if it wants to be sustainable. You can't ignore reality and substitute your own, no matter how much you want to.

Know Your Client, as I have applied it in the banking world, simply means that you only deal with customers that you know by name, you know where they live and you know how they earn their money. That way you can predict what they will do with their account after they come on board them and, most importantly, you can make a reasonable assessment of the risk they pose to your company. KYC doesn't end there though. Monitoring accounts for unusual behavior is even more important if you want to properly keep out the bad guys. If you don't perform periodic reviews and re-assess the risks you might as well open your doors and say, "here we are, misuse us"

Giving up on KYC is a terrible idea. The recent mega-fines handed to the big banks show that willful blindness will lead to criminal misuse sooner or later. Regulators will simply make you go away if you think you don't have to play by their rules. Complying in a cost effective and customer friendly way is key. We will move from an point of contact, face-to-face experience to a virtual, continuous, automated one. However, the end result will need to be the same. A thorough understanding of the customer. Not just to keep out the bad guys but to keep the good guys in.

Detecting Tax Evasion; a Practical Method

The last few years have been quite eventful for anti-money laundering specialists, due diligence gurus and other compliance enthusiasts. Not only has crime become more sophisticated, the attitude towards behavior that might have been frowned at but was mostly condoned has changed dramatically. 16 year old boys get arrested for making boisterous remarks on Facebook; the NSA tries to sneak a peak at everything you do online and you better make sure you pay your taxes in full or you’ll be lumped in with the terrorists, drug kingpins and other ne’er do wells of this world.

Regardless of one’s stance towards paying the emperor what the emperor is due, it is a fact that governments around the world have become acutely aware of their dependence on their constituency’s timely tax payments. Even the supposed inventor of money laundry, all-round bad guy Al Capone, was in the end only caught and convicted for tax evasion.

Singapore has made serious tax crimes a predicate offence to money laundering. Starting the 1st of July, financial institutions have to use their full suite of anti-money laundering systems and measures to detect and report serious tax crimes. Penalties for money laundering are severe and senior management (and compliance officers?) may be held responsible for the results. The big question that the compliance community seems to wrestle with is “How do I detect tax evasion?”

How to Start?

Most financial institutions take a risk based approach. If the risk of tax evasion is larger, they will review the account first. Some banks may have thousands if not tens of thousands of accounts which makes reviewing every account impractical.

What is a “tax evasion risk”?

There are a lot of ideas and definitions going around but a lot of them are based on the same methods that are used to detect money laundering. If tax evasion is a predicate offence to money laundering, it can’t be money laundering by itself. Nobody would say that prostitution, drug trafficking or kidnapping are money laundering but they certainly are predicate offences. Do banks have systems to detect prostitution? Are there vendors out there selling kidnap detection solutions to banks? Not to my knowledge.

A client that may be at high risk for money laundering may very well be paying all his taxes and vice versa. Simply using AML methods to catch tax evaders may very well give you a false sense of security.

So (as we say in Singapore) how then lah?

Risk vs Reward also known as Fear vs Greed

Apart from the moral and ethical implications, the temptation to evade taxes is a simple calculation of the money to gain versus the chance to get caught. It’s all about relativity. Albert Einstein once said “nothing happens until something moves” and this goes double for money. Look at anything that increases the chance to gain from tax evasion and decreases the chance of detection of said evasion.

For practical reasons let’s assume that if you earn a lot of money, you have to pay a lot of taxes. This leaves out the students that “forget” import tax on their new iPad that they bought tax free and the grandmother that sends some money to her grandchildren without realizing that she should have paid tax over that. Yes, they are evading taxes but most of the time they won’t open an off-shore account to do it. It also leaves out most low balance (retail) accounts as it would simply cost too much for a retail client to go through the trouble of off-shore tax evasion.

High Risk Jurisdictions

“The higher the risk of detection, the lower the temptation to move your money”

One of the most asked questions is “which jurisdictions are considered high risk from a tax evasion based perspective?” There is no easy to use list like the FATF list of high-risk and non-cooperative jurisdictions. Some senior bank managers close their eyes and stubbornly keep to the FATF list because “tax evasion = money laundering, so FATF must be right yes?” This would mean that a poor North Korean citizen would be a higher tax evasion risk than a wealthy German and an Iranian farmer would be more likely to evade taxes than a Japanese CEO. In my humble opinion this does not make a lot of sense but hey, whatever floats your pirate ship.

To determine risk, why not look at the taxes charged in the country of origin and the taxes charged at the destination? The higher the difference, the more tempting it is to move your money. You may also want to look at the risk of detection in the country of origin versus the country of destination. The lower the risk of detection, the higher the urge to move your money.This leaves out accounts that were moved between countries with an effective tax control framework and exchange of tax related information.

Since the 1st of July the risk of detection in Singapore went up more than a few notches. This is a good thing for everyone concerned except maybe for the tax evaders and the institutions with a lot of “legacy clients” that they accepted in the bad old days. Still, this may be a good time to weed out the few bad apples and become a truly world class bank.

High Risk Industries

Some industries are traditionally known for “under the table” payments and book cooking. This list may actually be surprisingly similar to the list of high risk money laundering industries. As with AML, look closely at any account movement that doesn't make economic sense.

Structures

Some people use complicated structures with multiple off-shore companies, trusts and other special purpose vehicles. There are many very legal reasons to structure your finances, even to avoid (not evade!) paying too much tax. The more complicated the structure, the more expensive it is to set up.

Of course, a structure also decreases the chance to get caught tax evading so unless the reason for the structure makes perfect sense, an account that involves a structure should be looked at more closely.

You may want to flag any account that isn’t a direct personal or business account and get legal and tax advice if things get too complicated.

Hold Mail

Most private banks offer clients the option to collect mail at the branch office instead of receiving it through the mail. In this age of internet, SMS and cloud based services there is little reason for someone to refuse receiving any kind of statement from their bank, especially if that bank is on the other side of the world. Sure, the NSA may be able to read your statements but if you really don’t want to know what is going on with your money you have other issues. Hold Mail without a very good reason should be regarded as a “red flag”.

Using a list of “red flags” to determine tax evasion risk may be too simple. There are many factors that cannot be caught by looking at red flags.

Let’s look at the definition of tax evasion:

“An illegal practice where a person, organization or corporation intentionally avoids paying his/her/its true tax liability.”

An important factor here is the intention of the individual. So why not ask a potential client why he wants to open a bank account, in your country, with your bank? If the reason is plausible, the account may be deemed a lower risk. There are many reasons to open an account in another country. The political climate may be stable. Lack of corruption and privacy laws make sure that nobody runs off with your money. Competent financial experts and a highly regulated environment keep your savings safe. All these factors and more make Singapore an excellent (if not the best) financial center in the world as well as a springboard to the growing markets in Asia.

What to do if a client opened the account and never visited? What if he kept his relationship manager in his own country and never even corresponds? If a client from a relatively high tax jurisdiction opens an account in a low tax jurisdiction without any reason or if he provides a reason that doesn't make economic sense, the account should be regarded as “increased risk”.

If you have a proper review process, existing accounts shouldn't prove too difficult. Your account managers will be revisiting their accounts regularly anyway. Most banks would have asked their clients a reason for opening the account, especially if the client is a non-resident. If your bank has not, it is time to revisit the client and find out. Excuses as “we don’t want to rock the boat and scare off our existing clients” will not work out in the long run as recent scandals have shown.

Mitigating factors

Anything that raises a “red flag” can be mitigated by an explanation. If a company gives full insight in their tax affairs and/or can provide audit reports will probably have a lower risk score. Individuals that are willing to provide a signed declaration or can provide an official declaration from the local tax authorities that all taxes are paid will be less of a risk than those who won’t.

Classification

Although tax evasion and money laundering seem to be used interchangeably, even by the regulators, I think that it merits having two kinds of classifications. One for money laundering risk and one for tax evasion risk. There are ways to score a “potential” client that are a bit more precise than the usual three or four tier risk classifications that most banks use. In the end it is the aggregated “compliance risk” score that should determine what kind of relationship (if any) you want to have with your client.

Moving Money

After classifying clients, it is time to monitor behavior. This is where traditional AML detection techniques come in handy. Are there any unexpected transactions? Attempts to avoid detection, like old fashioned structuring and layering?  Payments from third parties or countries that are known for tax evasion? Keep in mind though that it is very difficult, if not impossible to detect tax evasion in a single transaction unless it’s crystal clear what the origins of the funds were. Most money laundering methods need multiple transactions. Tax evasion can be committed without transacting at all, simply don’t pay taxes!

Conclusion

The methods described above may help to keep out tax evaders but will do less to catch tax evasion as it occurs. They won’t detect the merchant that keeps profits off the books or the plastic surgeon that receives payments under the operating table. Existing money laundering typologies can be used to detect tax evasion but don’t forget that there are other forms of money laundering and other predicate crimes. The job of a money laundering reporting officer is to report suspicious activity regardless of what the actual crime (if any) is.

Nobody don’t want to bank with an institution that is a known tax-evaders haven. Most wealthy individuals prefer privacy, which is hard to maintain if your bank is being investigated and in the news. Trust and reputation is everything, especially if you are a small private institution with few clients.

As I learned the hard way, bank management might be sorely tempted to tweak definitions and results to leave the majority of their clients off the hook and with the bank. In the long run, brutal honesty (at least internally) goes a lot further than self-delusion and willful blindness. It is the role of compliance to keep the bank operating inside the law but in the end it is senior management that makes the decision how to do that. Without a proper framework and established definitions it is still difficult to implement proper anti-tax evasion controls.

Please note that this post is based on personal experience  only, contains suggestions and is in no way intended as legal or regulatory advice. Feel free to contact me or post your questions or suggestions below. I am always willing to share some ideas.

As an investor I look at the future of the company, not at the past. In this case, the future of Apple looks less promising than all the analysts will have you believe. Apple has a few glaring weaknesses.

First of all, a large part of iProduct sales revolve around the near godly status of Steve Jobs. His attention for detail and ability to spin any (perceived) flaw of iProducts contribute at least 40% to current sales. With Jobs out of the picture, Apple will just be another company.

 Second weakness is (lack of) innovation. Contrary to what most fanboiz want you to believe, Apple isn't an innovator but an aggregator. It takes existing concepts (MP3 player, PC, mobile phone) and turns them into iProducts to take over the existing market. This worked with the iPod, the iPhone and the iPad. Question is, what is next? Unless Apple comes up with something truly new, it will be hard to redefine yet another market.

Third is competition. Apple rules the tablet market because it was the first company to come out with a usable combination of hard- and software. So far, the competition has been too divided to make a meaningful response. This will change very soon. Google has taken the first step by keeping the code of Honeycomb restricted. This will unify the Android market which will make it a more attractive platform to program for. It will also prepare users to start paying for Android apps, something that so far has kept the truly great apps off the marketplace.

The last weakness is Apples arrogance and with it; in-transparency and inconsistency. Apple has done everything it can to keep control of programmers and content providers. If Google plays it right, they will offer better terms and, more importantly, give programmers the feeling that they are partners and not underlings that ruled by the whim of the Appstore police and their overlord Jobs. Just visit the app developer forums and you get a feeling of how programmers feel when they submit their work to Apple. They often are like children waiting for a grade from their teacher. The murky politics behind it don't make that any better. Why is it that content providers were told that they couldn't submit anything even remotely resembling adult content but when Playboy comes in, Jobs' crusade against adult entertainment is suddenly put on hold? If the Android market can manage a transparent and consistent policy on what is allowed and what not, they will win this race. Last but not least, Jobs should stop treating customers as dumb ignorant sheep. If Apple decides not to support Flash, it should tel people the real reason instead of making up stories about "obsolete technology". Flash allows users to circumvent the appstore and play games for free. It also allows content providers to serve content without appifying it, denying Apple a piece of the pie. That is the only business reason Apple should and has denied Flash on it's products. 

It's true that investing in Android is not as easy as investing in Apple. One is a company, the other a platform. In the long run however, the risk that you take when you invest in Apple NOW might just be too great compared to the relatively modest rewards you will get. Will Apple still exist in 10 years time? Undoubtedly. Will it still be this mythical super company lead by a godlike CEO? Not likely.

Why Apple fans accept restrictions that other people don't

It has finally happened! No, not the fact that I became a father although that kind of overshadows everything else, but the fact that I have more Apple products in my house than other brand gadgets. I now own an iPad, an iMac, two iPods, an iPhone and am still considering to give my wife a Macbook. Does that make me a braindead "fanboi"? Not really. There are some things that I really don't like about Apple as a company. One such thing is that they put seemingly random restrictions on their products. The iPod can't play FLAC files, the iMac monitor has no connection for my PC except through a very expensive adapter and the latest one; the iPad doesn't play Flash.

It always amazes me how the real Jobites accept these restrictions and even defend them with the arguments Jobs is using. "Flash is "old technology", "Flash doesn't support multi touch screens","Flash is closed technology". Fansites like http://www.tuaw.com/ and http://www.appleinsider.com/ are filled with derogative comments about Flash followers and how Adobe should just roll over and play dead for the mighty Apple and it's 'pad.

I'm not saying there is no truth in what Jobs says. Flash has always been a memory and processor hog. But now Apple even wants developers to stop using Adobe tools to port or develop their games. Again, the arguments are deceptive as according to Jobs using Adobe technolgy automatically leads to inferior technolgy. "Amen" is the sound from the church of Apple. So how is it that people like Jobs, Gates and lately Warren Buffet (but that's another story) get away with simplified truths to push their ideas across?

New Scientist seems to have the answer: Brain shuts off in response to healer's prayer - life - 27 April 2010 - New Scientist

"When we fall under the spell of a charismatic figure, areas of the brain responsible for scepticism and vigilance become less active. That's the finding of a study which looked at people's response to prayers spoken by someone purportedly possessing divine healing powers.

To identify the brain processes underlying the influence of charismatic individuals, Uffe Schjødt of Aarhus University in Denmark and colleagues turned to Pentecostal Christians, who believe that some people have divinely inspired powers of healing, wisdom and prophecy. Using functional magnetic resonance imaging (fMRI), Schjødt and his colleagues scanned the brains of 20 Pentecostalists and 20 non-believers while playing them recorded prayers. The volunteers were told that six of the prayers were read by a non-Christian, six by an ordinary Christian and six by a healer. In fact, all were read by ordinary Christians. Only in the devout volunteers did the brain activity monitored by the researchers change in response to the prayers. Parts of the prefrontal and anterior cingulate cortices, which play key roles in vigilance and scepticism when judging the truth and importance of what people say, were deactivated when the subjects listened to a supposed healer. Activity diminished to a lesser extent when the speaker was supposedly a normal Christian (Social Cognitive and Affective Neuroscience, DOI: 10.1093/scan/nsq023).

Schjødt says that this explains why certain individuals can gain influence over others, and concludes that their ability to do so depends heavily on preconceived notions of their authority and trustworthiness. It's not clear whether the results extend beyond religious leaders, but Schjødt speculates that brain regions may be deactivated in a similar way in response to doctors, parents and politicians."

The same is apparently true about Apple fans.

So all I can do is remain critical because even though my gadgets have become dominated by the Great Fruit, I will resist ever getting an iBrain. Having said that, I'm going back to playing Civilisation on my iPad.

For some time now, I've been reading my books on an Amazon Kindle. Singapore weather has not been kind to my existing book collection and it hurts seeing my babies molding away in the few years that I've lived here. Besides that, I never seemed to have enough books with me when travelling.

I've also converted to the church of Jobs when I bought a 27" iMac. I'm not a complete zealot though and haven't yet decided on the iPad. One of the discussion on the net is the conundrum Amazon seems to be in. The Kindle is a fantastic book reader but the iPad is determined to steal the crown for itself.

Apple has a simple formula that always makes their products come out on top. They look at what other gadgets do and then come out with a super stylish version that seems to do better then everything else. However, they concentrate at the essentials. It's all about user experience.
Simplicity however, is the hardest thing to achieve. The biggest mistake Amazon could make is to compete with the iPad. They should make a Kindle that emulates book reading as close as possible, not make an all-singing all dancing multimedia slab.

Do's

First of all the format. The iPad is about 20% too small to comfortably read comics without scrolling. So make the screen 12" or loose the bezzle and you cater to the thousands of comic book fans out there. It would also cater to the elderly who need big letters to read books comfortably. With a bigger screen you won't have to turn pages that often.

A color screen is a must but only if it is as readable as the e-Ink screen the Kindle is using now. The whole point of e-Ink is to emulate paper. The iPad could never do that so there is an opportunity for Amazon to distinguish itself.

Touch is a must have to emulate real book reading. However, with touch come finger prints and -smears. Make the screen as dirt resistant as possible. The current Kindle screen is perfect although the bezzle gets black stains very easily.

System speed is a big issue on all ebook readers. If the screen is responsive and books appear instantly the user experience would be much better. It would be great to emulate page turning like the iPad app does. However, coming back to comics and magazines, I remember going through the racks in the comic book store to find missing issues so why not emulate that as well?

One of the greatest features of the Kindle is the long battery life. Extend that to a month or so and you have a winner.

A large target group could be students. Amazon missed out when the Kindle was found to lack support for blind people. The limited annotation capabilities are another issue. Instead of including a keyboard or using (shudder) touch screen typing, why not market a separate keyboard with dock like the iPad has? There could even be a separate braille attachment.
Most important of all: content! With exclusive deals, special editions and a low pricing model for older books you can leverage on your position in the reading market. Don't get greedy but give your customers (readers AND publishers) a fair deal.

Don'ts

Apple rules the app market. Please don't get into that with the Kindle! Programmers will use their time on the largest potential user base so you would only get the bottom of the barrel programmers or ports from already existing apps.

Movies, music, TV whatever other multimedia. Besides the iPad, there are dozens of MP3, MP4 and HD capable streamers out there that can do the job. Concentrate on books, comics, magazines and newspapers! This doesn't mean the basic MP3 player should be out. For audio books or a tune or two during reading, the Kindle is still excellent. Anything more, make a truly great portable music device but don't use the Kindle for that!

Gaming. Kindle is a book reader, not a gaming platform. Besides maybe cross word puzzles and sudoku, leave gaming to the PSP, DS and iPad.

Sustainability and the Austrian School

In my previous roles as program manager for sustainability at ABN AMRO Bank I often had skeptical managers trying to argue that sustainability was a fad and contrary to sound economical behavior. I have since moved on but sustainability has trancended from a activist “use both sides of the toiletpaper” oddity to a permanent item on the board agenda.

Last Friday there was an interesting article on mises.org, the website of the Ludwig von Mises institute. For those of you unfamiliar with Ludwig von Mises; he was one of the forerunners of the Austrian school of economic thought. The main premise of the Austrian school is that human behavior is too complex to develop mathematical models of evolving markets. It is often seen as an extreme libertarian stream because Austrian economists largely reject government interventions but believe that the power of pricing organizes the market.

Although I am a long time follower of the Austrian economic school of thought, I refuse to let myself be swept away by “Austrianism”. Like socialism, it is a very tempting idea that works best if everyone follows the rules. Unlike socialism, Austrian economics stops working whenever politics come into play. Off course in practice politicians seldom stay out when money and electoral power are at stake.

Tyler A. Watts, a PhD candidate in economics at George Mason University takes a shot at what he calls “the sustainability movement”. Like any proponent of an idea he doesn’t fully understand but is against anyway, he starts out with labeling sustainability as an “-ism”. The same technique is used by religious zealots when they talk about the ideas of Darwin. It makes the attack easier because you can dismiss any rational argument with the counter-argument “it’s a belief, not a fact”. It also makes any attack more personal because you can group the “believers” into a homogenous category which makes for a larger target. Watch out! The sustainists are out to control us!

As Watts tries to make his readers believe, sustainability is all about control of the market. “(Sustainists) are damning in their fervor, poise, and rhetoric. Their ideology is pregnant with an accusation that the way things currently are is somehow unsustainable.”

The rant gets even more polarizing when Watts argues that: “The sustainability movement is an assault on economics. It claims at its core that prices don't operate through time to direct consumption and production decisions in a sustainable way. A lesson in basic economics should suffice to defend against the sustainists' attack.”

Apparently Wattsists know exactly what sustainability is all about and companies that operate in a sustainable way are a threat to the free market. Unfortunately for the not-ye- existing Wattsist movement, practice has shown that sustainable behavior in the market has nothing to do with intervention but everything with supply and demand.

One of the arguments that Watts brings to the table is that “prices arise in the market economy as a concomitant of mutually beneficial exchange. People want things that improve their lives — we call this value. (…)The price of any good reflects this combination of value and scarcity.”

Apart from the fact that diamonds are expensive not because of scarcity but because their price is tightly controlled, what is ignored or forgotten here is that “value” is not only determined by price and scarcity but by (perceived) quality as well. Apple products are more expensive, not because they are scarcer than comparable products but because they have a (perceived) higher quality.

High quality commodities can become so expensive that few can afford them. According to Watts, water is abundant and therefore sustainists (which my MS Word spellchecker suspiciously wants to change to “Satanists”) needlessly worry about depletion. If water becomes scarcer, prices will go up, consumers will use less and entrepreneurial scientists will invent substitutes. The market will control itself. What Watts is basically advising is to use resources as much as possible until they become too expensive and then find a substitute.

What will happen if we were to follow the Wattsist behavior? Empirical evidence can be found in countries like Ethiopia and Sudan. Clean water is scarce there and people are poor. The ratio of water price vs. average income is extremely high. The result is that people drink whatever is available. One out of three children dies of diarrhea.

Watts’ solution to the price dilemma is simple: “if the price of a good trends strongly upwards over time (indicating it has become scarcer and/or more valuable), they rush to find cheaper substitutes”. I wonder what substitute for clean water is being researched in the labs of George Mason University.

Watts argues that “prices reliably guide individuals, both consumers and producers, toward a rational use of resources.” Theoretically this is true. In practice however, humans tend to have an economical horizon, both in fore- and in hindsight. Managers rarely think more than 5 years ahead. An earned profit now is often better than a possible profit in the future. This is especially true if you expect to be promoted away from your responsibility anyway. Unsustainable use of resources may sound very attractive. It keeps prices down and margins and profits are higher. Who cares about the time when resources become expensive? Let my successor worry about that!

Free markets are a crucial part of a world where prosperity is divided in a fair and equal way. This doesn’t mean that one should blindly follow every idea that comes out of the Austrian camp. The most attractive and in my humble opinion most valid argument for Austrian economics, is Mises’ premise that every conscious action is intended to improve a person's satisfaction.

True sustainability isn’t about “going green” or intervention in healthy market behavior. It’s about long term true value that is not only determined by price and income but by our satisfaction with the way we live. Even from Watts’ own somewhat cynical point of view, sustainability makes sense. It has created a huge, multi billion dollar industry and isn’t that what free market is all about?

Dubai goes pop

It’s been an incredibly long time since I wrote anything, which I blame squarely on my workload instead of my laziness off course. However the events of last week in Dubai have renewed my interest in writing at least a little bit even if it’s just so I understand it myself clearly.

Dubai’s state owned investment company, Dubai World had to postpone repayment of part of its crushing $59 billion debt, including $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. The Dubai World announcement came less than two hours after Abu Dhabi, the capital and wealthiest emirate in the U.A.E., bought $5 billion of Dubai bonds as part of a $20 billion support fund to help reorganize state companies.

Investors, journalist and the whole financial industry held its collective breath and braced for impact. Off course Dubai’s oil rich sister state Abu Dhabi and the rest of the UAE will not allow Dubai to fail. It’s just a matter of how many pounds of flesh the ruling house has to shed to make sure that their dream of a thousand and one nights will stay alive.

However, will this work in the long term? Whenever I’m in Dubai I’m always amazed by the scale of the real estate projects. There seem to be more shopping malls than people and at one time the largest part of the world supply of construction cranes could be found in Dubai.

The problem with shopping malls though is that you need shops and that means shoppers. The thing is that there doesn’t seem to be a lot of incentives for locals or tourists to shop in the cavernous Mall of the Emirates or the gigantic Dubai Mall. The local population is so rich that they rather fly to Paris or London to do some real shopping which leave the tourists. The price of electronic goods and clothing, two things tourists shop most for, isn’t much lower than in any comparable Western shop. D&B, Gucci and friends can be bought for less in Amsterdam. Sony, Samsung et all can be had for less in the malls of Hong Kong or even Singapore.

So if it isn't the shopping, what will attract tourists? Culture? Unlike Abu Dhabi, which agreed to pay France $1.3 billion to borrow the Louvre's name and hundreds of its artworks, as well as treasures from the Picasso Museum, Pompidou Center, Chateau de Versailles and other French museums, Dubai borrowed even more money to build Dubailand amusement park. Apart from the small but interesting local museum, there’s not much else to do. Dubai is notorious when it comes to nightlife but I doubt that the authorities really want that kind of image for their Islamic state.

A lot of people think that Dubai is oil rich, just because it lies in the Middle East. This is not so. Abu Dhabi has enough oil to guarantee revenue in years to come but Dubai saw the need to diversify years ago and borrowed heavily against its real estate assets. Doesn’t it sound familiar? Someone who borrows money against his house to afford a lavish lifestyle? It’s the mortgage crisis on a country wide scale!

Let’s have a look at Dubai’s current financial position. It has always been a well kept secret but the debt crisis forced the Dubai Executive Council to give a little insight:

Sovereign debt: $10.000.000.000
State-affiliated debt: $70.000.000.000

Sovereign assets: $90.000.000.000
State-affiliated companies assets: $260.000.000.000

This means that the total debt of 80 billion is covered by 1.3 trillion in assets. How many of these assets need to be written down to more realistic values if the Dubai real estate market continues like it is? Most of Dubai’s prestigious projects were conceived on the basis of making a quick buck. When stripped from all their glamorous hype, the Palm and World islands are just sandbanks with buildings on them. Sure it’s nice to have Brangelina as your neighbors but who would want to live on a sandbank?

Now that foreigners are fleeing the country to avoid debtors prison (yes there is such a thing in Dubai), the glitterati must really consider if they want to be associated with this less than glamorous reality. No celebs means no wannabes that are willing to pay the big bucks and that means re-evaluating real estate (yet again).

Again, this should sound eerily familiar. If Dubai can’t refinance, it will have to sell and if the assets values are going down, friendly uncle Abu won’t be around forever for the bail out.

That leaves the regular options that any sovereign state has at its disposal. Argentina and Russia, two states that hovered at the same brink of financial destruction restructured and raised their taxes. Both countries have a sizable domestic workforce and enough GDP based on tangible production. The issue with Dubai is that it has neither. The local workforce is largely comprised of imported construction workers, domestic personnel and white collar expats. Tax is negligible and for the domestic population, most public amenities are free. The real estate boom ground to a halt even before the Dubai debacle hit. Dubai’s best bet for the future would be modest spending habits combined with leverage of its central position between the East, the West and Africa. Expanding Dubai’s role as importer/exporter with excellent port and airport facilities could start the revenue engine again. Financial and political transparency is crucial if the image of the desert state as an overspending family owned business is to be changed. Time to sell the Ferrari and pawn the bling bling. If not, Dubai World will be only the beginning of the bursting bubble.