The desert bubble has burst

A few years ago Dubai launched an advertising campaign announcing that the emirate would build a "bubble city," a project featuring restaurants and museums suspended in the air by giant helium balloons and enveloped in transparent material. It was nothing more than a public relations exercise promoting a project that was never really planned to be built. But what was created in practice also gave the impression of a "bubble" of another kind from the first day the bulldozers broke ground on the site.

But what actually was built? A conglomeration of artificial islands that form the shape of the world, designed to accommodate Western millionaires on their own private islands; another artificial island in the shape of a palm, where hotels and vacation homes were built, including the most luxurious hotel in the world; a ski resort in the middle of the desert that is 85 meters high and has five trails, all encased in a huge glass dome in which the air is cooled to minus 6 degrees Celsius; plus two of the tallest buildings in the world and a street of skyscrapers like you might see in New York or Shanghai. And all of it green, new and air conditioned.

All this was built in the middle of the desert by little Dubai, which is part of the United Arab Emirates. The emir of Dubai, Sheikh Mohammed bin Rashid Al Maktoum, sees his city as a miracle and, according to information gleaned about him, is seeking to foment no less than an Arab renaissance by creating one of the largest financial, entertainment and tourist centers in the world. However, Dubai is in fact an expanse of arid land, without oil, and to make the sheikh's dream a reality, the emirate needed to secure credit on the world financial markets.

How much credit? It's not clear. The Dubai economy is a mix in part of commercial firms, the ruling family's own enterprises and state-owned entities. According to estimates by Western analysts, Dubai's debt comes to more than $80 billion, most of which is owed to Arab, British and other European banks. What is the actual connection with the government of the UAE? That is also not clear. UAE's central bank as well as the central bank of Abu Dhabi - the richest of the seven emirates - provided an additional line of credit to Dubai this year, but they did not officially undertake to guarantee its debts.

House of cards

One thing that is clear is that the emir's megalomaniacal real estate project has run into trouble. The rich Europeans, Asians and Americans who were supposed to buy the luxury vacation units that are being so carefully built have decided, in light of the world financial crisis, that they have no interest in another villa in the middle of the desert of all places. The result: Real estate prices in Dubai have plunged by 50%.

Everyone who has come back from Dubai recently reports that the place is paralyzed. There's no money, no demand, the projects are at a standstill and the atmosphere is one of gloom. The air has quickly gone out of the desert bubble, and after delay and evasion, the state-owned Dubai World Corp. was left with no choice: Last Thursday it announced that it was seeking to have $59 billion in debt rescheduled.

World markets have fallen in response to that decision. Asian stock markets dropped by about 5% in two days of trading, while the dollar rose and sterling fell. Oil and gold plummeted and government bonds skyrocketed. European markets fell more sharply than they had in seven months, recovering somewhat only at the end of trade on Friday. The American markets responded with modest declines compared to Asia and Europe, but real estate stocks were down sharply. Dubai has holdings in a range of well-known properties, such as the MGM casino in Las Vegas and the Mandarin and W hotels in New York, and now there is concern that these properties will be put up for sale at bargain-basement prices.

Ultimately, Dubai is yet another big and particularly unsustainable real estate project for the wealthy that succumbed to the force gravity and fell to earth. The rescheduling of its debt will not create a crisis, however. Goldman Sachs has calculated that Dubai's two major Western lenders - HSBC and Standard Chartered - could write off several hundred million dollars each, but such sums are less than 1% of their capital. According to Credit Suisse's calculations, the total exposure to Dubai's debt on the part of Western banks comes to $80 billion, and even loss of half of the debt would only result in a 5% increase in doubtful loans - an increase that would only cause the banks to suffer losses of 5 billion euros. It's not nice, but it's also not so horrible. The amount involved is a drop in the bucket compared to losses in 2008 and 2009.

There won't be any nerve-racking negotiations with institutional lenders either. Sheikh Mohammed won't give back his airplanes or provide controlling shares in the emirate. Plus, on the other hand, his cousins in the other emirates might well float him some credit in an effort to avoid irreversible damage to the prestige of the entire region.

It is easy in this case to engage in cliches and word games: One should have seen the writing on the wall with regard to Dubai's financial desert storm, and anyone who didn't see it coming had their heads in the sand.

There will be no serious direct damage either to the banks or to Western investors. But pressure was felt on the markets. Why? It's quite simple. For investors, Dubai is an example of the old story that says that if it looks like a duck, quacks like a duck and walks like a duck, it usually is a duck. And stock markets, credit markets and some real estate markets have within the past three months all been walking like a duck. Many of the markets have shown increases beyond what is rational, as a result of low dollar interest rates together with an infusion of speculative funds, with the encouragement of hedge funds and other interested intermediaries. Experienced traders, bankers and business people know there are many other Dubais in the marketplace, corporations, holding companies banks, other entities and especially real estate projects that in the current reality cannot meet their obligations. All of them could announce that they are insolvent tomorrow morning.

Dubai's bankruptcy reminds many people that it is the fate of every bubble ultimately to burst. Dubai's default reminds everyone how much the markets, especially the real estate market, are inflated, how sensitive and delicate their structure remains and how easy it is to topple a house of cards.