Dubai Not a Disaster but a Stop Sign?

The announcement that Dubai World, the state-owned investment/development arm of the emirate of Dubai on the Persian Gulf, wants to postpone payment on some $60 billion in debt by six months sent immediate shock waves through the world financial system last week. But markets recovered Friday and Monday, suggesting that while Dubai's troubles are significant and may presage further defaults, they won't send the international financial system into the tank — yet.

Dubai is one of the United Arab Emirates that is not wallowing in oil riches, although it has access to credit through the UAE, most of whose members are oil-rich. It has tried to promote itself as something or a tourist destination — something like the Las Vegas of the Middle East? — with projects that are brilliant, eccentric or daft, depending on your perspective. The world's tallest skyscraper? An indoor snow skiing slope in the middle of the desert? An artificial island shaped like a palm tree to be covered with mansions?

Dubai World developed or helped to finance such projects, as well as buying real estate all over, including luxury hotels in the U.S. and golf courses around the world. With the international financial crisis precipitated by the U.S.

mortgage crisis last year, most of these investments turned sour. Some experts estimate that real estate prices in Dubai itself have fallen by half over the last year — although since there are no ready buyers it is difficult to arrive at an accurate figure.

Esmael Adibi, director of the Anderson Center for economic forecasting at Chapman University, told us the Dubai debacle suggests strongly that "excessive risk-taking was a worldwide phenomenon," not one confined to the United States. Most of Dubai's debts — "only" about $60 billion — are with UK and Western European banks; U.S. banks had very little exposure there. So it wasn't only the Federal Reserve in the U.S., with low interest rates, that encouraged excess borrowing and leverage. It happened all over.

Mr. Adibi wouldn't be surprised to see other "sovereign wealth funds" created largely by oil-rich countries run into problems as investments turn sour.

Some observers lamented that this crisis would cause banks to become even more conservative in their lending policies, thus delaying economic recovery.

We're not sure that's undesirable. Banks got a little stupid during the recent bubble. A sound recovery will be based on sound lending practices, not lending willy-nilly. A reminder that banks can suffer from "irrational exuberance" too is not necessarily a bad thing.

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