Dubai's story of hotels and hubris in the desert sands is well rehearsed, but where will the narrative end? A relatively happy conclusion would be for the damage to be localised and containable, for Abu Dhabi or the International Monetary Fund to step in as backer, and for world markets to regain a measure of calm. An unhappy denouement hardly bears thinking about.
The only surprise about the downfall is that it came as a surprise. Neighbouring Gulf states could see it coming and have been keen for some time to differentiate themselves from their wayward brother emirate. On a recent visit to Qatar, everyone bent my ear about the huge contrast between them and Dubai. To be fair, if Dubai is the Middle East's answer to Las Vegas, Qatar is the equivalent of Halifax, Nova Scotia.
With little oil to its name, Dubai set about transforming itself from a small pearl-fishing port to the "eighth wonder of the world", with the seven-star Burj al-Arab hotel, the shopping malls, the expat villas and vaunting ambitions to become a world-class financial centre. But the improvident Gulf state traded oil-dependency for property-dependency – or, more accurately, debt-dependency.
The Qataris and others in the Gulf fear that Dubai will bring the entire region into disrepute, confirming western prejudice and suspicion, and casting doubt on the fledgling, but fast-growing Islamic finance market.
Exactly how bad the financial situation is, nobody really knows; the distinction between the personal holdings of members of the ruling al-Maktoum family and that of the state is unclear.
Dubai World, which triggered the crisis by saying it wanted to suspend its debts for six months, is an investment vehicle of Sheikh Mohammed bin Rashid al-Maktoum, one of three government-controlled conglomerates. The accepted figure for Dubai's debt was $80bn, but Dubai World recently declared borrowings of $60bn to the Nasdaq stock market, and it is not known if the liabilities of Dubai Holdings, another government entity, are included in the figure. Some analysts suggest that a more realistic estimate could be in the order of $150bn. Neither is it clear, at the time of writing, what support will be forthcoming.
It wasn't supposed to be like this. Early in the credit crunch, Middle Eastern investors with deep pockets were looked upon as potential rescuers of western banks, such as the Qatari and Abu Dhabi investors who allowed Barclays an expensive escape route from the clutches of the UK government. However, the Dubai meltdown demonstrates the problems with the lack of transparency and accountability of some sovereign wealth funds and similar investment vehicles.
The contagion is difficult to assess at this stage. European banks may be in line for losses on an estimated £40bn of exposure to Dubai, and there are also question marks over the implications for western companies owned or part-owned by the emirate.
The London Stock Exchange found its own shares taking a hammering because of fears that the Dubai bourse might be forced to sell its stake of more than 20%, and although there are no immediate issues over the former P&O ports, the downfall of Dubai yet again brings into doubt the wisdom of selling strategic businesses to foreign owners, an issue that regular readers of this column will recognise as a long-standing concern of mine. City figures and politicians have repeatedly dismissed my misgivings on the takeovers of UK companies by overseas predators, such as Kraft's assault on Cadbury, as backward-looking and unrealistic. What would it take for them to admit they can be risky and damaging?
However the Dubai story ends, it is likely to be one of the pivotal moments of the crunch as the fear of bank defaults has turned into the fear of government defaults. Activity in the market for sovereign credit default swaps, a type of insurance for governments defaulting on their debts, indicates concerns about Greece, Italy and others, which in turn prompts questions about the stability of the eurozone.
I am not suggesting an imminent sovereign debt meltdown, but excessively leveraged countries are vulnerable, just like over-geared banks.
Dubai has brought home the fact that, despite the relative calm of recent months, the fundamental issues that caused the crunch – excessive borrowing and global imbalances – are still there. It also shows that any country which believes it can secure prosperity on a property boom and consumer bling (sound familiar?) is pinning its hopes on a mirage.
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