The city of gold turns to dust

Dubai is a financial mess. Who’s to blame for the collapse?

Only yesterday, it seems, Dubai was the glittering jewel of the United Arab Emirates, heralded as the first modern Arabian metropolis, a 21st-century socio-political model, globalization in action. Now the autocratic fiefdom that counts Barneys New York, the Travelodge chain, and a 20 per cent stake in Cirque du Soleil among its holdings boasts a new claim to fame: the most over-hyped, over-the-top asset bubble in history. This week, worldwide markets tumbled amid fresh fears of the global economic fallout from Dubai’s financial mess and the dawning realization that its finances are far more shadowy than ever imagined.

Certainly the government’s annoucement two weeks ago that it couldn’t meet its debt repayments was carefully calculated: it chose the eve of the market-closing U.S. Thanksgiving holiday and the four-day holiday marking Islam’s Eid al-Adha feast to report it had asked creditors for a six-month standstill, and was scrambling to restructure US$26 billion of its total debt of US$59 billion. Then, it announced that debts carried by its tangled web of state-owned companies, among them holding company Dubai World and property developer Nakheel, might not have government backing. Global markets panicked when the UAE, a federation of seven emirates led by oil-rich Abu Dhabi, didn’t rush to bail out its second largest member. Some equilibrium was restored when the UAE set up a lending facility to ensure Dubai’s banks had sufficient capital, and after Abu Dhabi announced it will selectively “pick and choose when and where” to alleviate Dubai’s financial woes.

Those woes should come as a surprise to no one. Christopher Davidson, a fellow of the Institute for Middle Eastern and Islamic Studies at Britain’s Durham University, predicted Dubai’s crash in his 2008 book Dubai: The Vulnerability of Success. “It’s amazing, really, the lack of due diligence done on Dubai in the last several years,” he says. Part of the problem, he notes, was Dubai’s confusing operating structure, which he says was deliberate. “The grey area between what belonged to the ruler, what belonged to government and what belongs to commercial entities served the ruling family extremely well: they could just cream off unknown amounts. Now the going gets tough and we have the ruling family and government washing their hands of these companies, making ludicrous statements that Dubai World is government-owned but doesn’t enjoy government guarantees.”

Dubai’s financial woes were also flagged in October 2008 by a Moody’s Investors Service report that state-owned companies owed at least US$47 billion, more than the emirate’s gross domestic product. Local media is censored, subject to severe fines for publishing anything that might damage Dubai’s reputation, but stories have been leaking out for a year about plummeting real estate values, abandoned projects and financial distress, most notably reports of the mass exodus of foreign white-collar workers who’d flocked to the city state during its go-go years, lured by a quality of life unavailable at home—tax-free salaries, luxurious housing, and cheap domestic labour. Thousands of cars have been abandoned outside Dubai’s airport, many with keys left in the ignition, some with maxed-out credit cards in the glove compartment. Under Dubai’s sharia law, punishment for owing money is severe. Residents can go to jail for bouncing a cheque.

Hence the spotlight on Dubai’s debt-mired leader, Sheik Mohammed Bin Rashid Al Maktoum, once viewed as a benevolent, luxury-loving despot who ran the emirate like a Fortune 500 company. It was his idea five years ago to turn the non-oil-producing emirate into a financial and tourist hub unlike anything the world had seen.

For a time he succeeded, creating a fantastical city state that was part Walt Disney, part Albert Speer, its phantasmagorical Blade Runner-esque skyline dotted by 25 per cent of the world’s crane supply. Billions flowed into the first “post 9/11” Arabic city, a hedonistic playground in the middle of Islam. One of its biggest cheerleaders was former U.S. president Bill Clinton, who called the place a “role model” for merging Islamic and Western values and cultures. In the years after 9/11, Dubai was embraced as a moderate Muslim country, says Davidson: “Neo-conservatives were willing to overlook its dictatorial government on the grounds that it promoted an alternative to political Islam.”

Also overlooked were the inhumane conditions inflicted on the hundreds of thousands of foreign workers, most from India and Pakistan, imported to construct the place to awe-inspiring effect. Nature was stage-managed at great expense, both financial and environmental: lush golf courses in the desert; a ski hill inside the world’s biggest shopping mall; sand rearranged on offshore islands that replicated a map of the world (with Israel notably absent). No expense was spared to bring celebrities to burnish the Dubai brand—among them Tiger Woods, Roger Federer, and Clinton. Dubai proposed a new oxymoronic economic model: state-owned capitalism. It was a trade-off: personal freedom for the promise of the best “quality of life on the planet,” like George Orwell’s 1984 with Gucci, McDonald’s, and a happy ending.

Easy credit allowed the Maktoum family’s private Dubai Holdings to go on a global spending spree. It snapped up marquee assets at market peaks—US$1 billion for a stake in DaimlerChrysler, US$1.5 billion for Tussauds Group wax museums, close to US$1 billion for Barneys New York, US$5.1 billion for a stake in the MGM Mirage, US$100 million for the Queen Elizabeth II liner, which it planned to convert into a floating hotel, as well as strategic ports around the globe.

Now the Dubai dream is kaput. “No big player can do business with Dubai now,” says Davidson. “The cost of insuring debt is too high to make it a legitimate business partner and that’s not likely to change.” People view it as a Dubai-centric problem, he says. “So I don’t think the rot will spread. Still, people will look at this and say, ‘How much more will unravel now?’ ”

That question could take years to answer. Respected analysts don’t trust government numbers. Last week, Moody’s upped Dubai’s estimated total debt to US$100 billion. EFG Hermes, a regional investment bank, thinks it could be as high as US$150 billion.

Next up on the Dubai debt calendar is Dubai World’s payment on a $3.5-billion Islamic bond held by Nakheel, due Nov. 14. A crunch creditors’ meeting is scheduled for Dec. 21. Rothschild Bank and Deloitte have been called in to help restructure Dubai World, with the directive to sell assets; this week, the finance minister announced the process would take more than six months. Dubai is angling to keep its profitable properties, among them DP World, the world’s third largest ports operator, and Dubal, Dubai’s aluminium company. State-owned Emirates Airline, the Middle East’s largest carrier, is also off the table—for now. Abu Dhabi, which owns competitor airline Etihad, is rumoured to have offered to buy it, only to be rebuffed. Should it succeed, the fallout could spill over into the aviation sector: between them, the two airlines have more than 400 aircraft on order from Boeing and Airbus; consolidation would result in both companies’ stocks taking a beating.

Up in the air too is Dubai’s Cirque du Soleil stake. Late last week, the Montreal-based company’s spokesman Tania Orméjuste said Dubai’s financial meltdown has had no impact. “Dubai World had already paid its investment,” she wrote in an email, after turning down an interview request. “Our operations as well as our business relationship with Dubai World doesn’t change.” This week, the government announced that the Cirque du Soleil stake was on the block, along with the QEII.

The UAE could have easily bailed out its profligate member, Davidson notes. The current jockeying between Abu Dhabi and Dubai is about politics, not economics, with Abu Dhabi using its financial leverage to reduce Dubai’s autonomy and close links to Iran by shutting out companies and creditors associated with that country. A regime change could be part of the plan as well, particularly given rumours that Dubai Holdings is also insolvent, says Davidson: “They’ve misled investors either wittingly or due to incompetence; neither is particularly palatable. The loss of legitimacy [to the UAE] is massive.”
Still, he doesn’t underestimate Dubai. It’s “a wily operator,” he observes, and its desire for autonomy could lead it to bailout discussions with Iran. “That is the nightmare scenario for Abu Dhabi and the other emirates,” he says. Saudi Arabia, also on poor terms with the UAE, could be another potential Dubai ally, he notes.

The first casualties of Dubai’s burst bubble range from the families in India and the Philippines who depended on money sent from workers, to European banks, among them Standard Chartered, HSBC Holdings, Barclays, and Royal Bank of Scotland, which are estimated to have loaned a total of US$50 billion. Jobs will be lost, Davidson predicts. Even racehorse markets have been affected: only two days after Dubai World asked for a stay on its debt repayment, Sheik Mohammed’s bloodstock adviser spent close to US$2 million buying eight foals. Last week, at mare sales in England, he was unusually frugal. “It’s the first time that anybody can remember that we didn’t see him buy anything,” one breeder told the Financial Times of London.

It may mean nothing. But given the confounding financial mirage that is Dubai, that could be the most ominous indicator yet.

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