Much Ado About Dubai

The panic over its debt problem tells us more about investors than it does about the emirate.

By ZACHARY KARABELL

Global markets sank sharply at the end of last week on fears that Dubai World, a subsidiary of the government of Dubai, was on the verge of defaulting on approximately $60 billion of the emirate's $80 billion in total debt held by creditors world-wide. The rush of news stories added to the wildfire of panicky speculation, with headlines ranging from "Dubai Default Risk May be Big US Bank Problem," to "Dubai Shows Limits of Government Rescues."
The mini-panic, however, has little to do with Dubai and everything to do with the tenuous psychology of global investors still skittish after the financial crisis that hit in the fall of 2008.
The challenges that Dubai faces are both well-known and at least a year old. In the wake of the global financial crisis, Dubai's debt was seen as one of many international soft spots, especially since most of the debt was tied to the assumptions that oil would stay above $145 a barrel, and that Dubai would continue to make the fantastic real-estate gains that had characterized the previous years.
The much-lauded and debated Dubai development model depended in part on a well of capital secured by oil and buoyed by the confidence of the emerging world. That confidence led to the creation of man-made islands, ski slopes in the desert, and some of the world's tallest buildings. It also led to aggressive foreign investments in a portfolio that included luxury stores such as Barney's and frivolities such as Madame Tussaud's wax museums.
What led to Dubai's rise was a vision of Arab entrepreneurialism, easy credit, and anything-is-possible attitude that epitomized the "if you build it they will come" philosophy. It was and is a dynamic materialistic outpost in a corner of the world more identified with religious and ethnic strife, and for a time it seemed to break free of the mooring of history. If nothing else, Dubai is the shopping mall and nightclub for much of the region.
Its obituary was written in the aftermath of the financial crisis as yet another icon of hubris. But Dubai is part of a United Arab Emirates confederation that includes Abu Dhabi and Sharjah, which have oil wealth that Dubai lacks.
As Dubai's ruling family preened, the neighboring emirs sulked, and when Dubai's debts came due prematurely, they swooped in, replete with the scolding I-told-you-so's and armed with billions in oil dollars. Unique model aside, Dubai was always a story of wealth expatriated from Abu Dhabi, Saudi Arabia, Kuwait, and, more opaquely, Iran. If there was ever an example of too big to fail, Dubai was it.
Dubai will not default on its debts—its neighbors simply will not allow it and as of yesterday they have pledged not to. They can well afford to bail out their cousin, though not without extracting a price for the infusion of funds. At one point early this year, with oil heading to $30 a barrel, it was possible the money wouldn't be there. But with oil near $80, the sovereign wealth funds of Abu Dhabi that have been conspicuously silent of late have their hundreds of billions.
Dubai is central to the fate of those who will bail it out. Rich-as-Croesus neighbors, whose conservative culture precludes the carefree amoral opportunities offered by Dubai, use the country as an escape valve. More important, Dubai remains a vital hub of banking, financial markets, deal-making and real estate development that is not about to pass quietly into that good night.
The panic in global markets, as absurd as it was, indicates a fragile state of mind that can do damage. If Dubai had defaulted, it's not as if all $80 billion owed would be written-off like some foreclosed subdivision in central Florida. There is still cash-flow, and no sane bank would willingly forgo that and refuse to renegotiate the loans.
Even a doomsday scenario for Dubai—complete default—wouldn't be a global disaster. While $80 billion is a lot of money, it is still $100 billion shy of what the U.S. government paid to keep American International Group afloat, and it is a pittance in the pool of tens of trillions in bonds world-wide.
So why did markets react as they did? Panic is the easy answer, and global investors do at regular intervals overreact. More disturbing is the possibility that investors in the traditional financial capitals of Europe, the United States and Asia have no better understanding of the world now than they did before last year's crisis.
The old centers—New York, London, Frankfurt, Tokyo—fear risk in parts of the world they deem emerging and underplay the risks in the offices next to them. They view the Dubais, the Shanghais and the Rios with suspicion and with errant conviction that their models are built on foundations of sand, ready to collapse, when it was their own foundations that have proved to be weak. Judging from the misguided reaction to Dubai's challenges, the past year hasn't changed those attitudes. That should make us worried, very worried, but not about Dubai.
Mr. Karabell is president of River Twice and author most recently of "Superfusion: How China and America Became One Economy" (Simon & Schuster, 2009).