What went wrong in Dubai

The boom years of the early 21st century were good for many people, but perhaps no one enjoyed them more than Sheikh Mohammed bin Rashid al Maktoum, the ruler of Dubai. Stripped to its essentials, Dubai is a sweltering strip of sand blessed with a natural harbour known as the creek, which has been an entrepot for merchants and smugglers for centuries. Building on his father's vision, Sheikh Mohammed turned Dubai into a 21st Century boomtown, luring western financiers and tourists with gleaming steel and glass towers, vast beaches, and green golf resorts.

Now Sheikh Mohammed is calling for a standstill on debt repayments at one of his most important companies, Dubai World, least temporarily rocking world markets and raising huge questions about the future of Dubai. The Standard & Poor's 500 index of 500 stocks fell 1.7% in abbreviated trading Friday, to 1,091.49, and the MSCI Emerging Markets Index had slipped 1.8% as of 2:12 p.m.

Dubai was always a momentum play. Unlike Saudi Arabia or Abu Dhabi, the hugely wealthy emirate to the West, Sheikh Mohammed had scant oil production to fuel his grandiose ideas. Instead he sold the world on his vision of Dubai as a hub for the Middle East, western Asia, and Africa, attracting investment from his wealthier neighbors—both Arabs and Iranians—and increasingly, from the West and Russia.

For a while, it worked. Western bankers fell over each other to book space in his Dubai International Financial Center, a handsome if somewhat over-the-top real estate project aimed at being the Wall Street of the Gulf. The cream of technology companies and media companies, from Cisco Systems to Microsoft, set up shop in Dubai's Internet City. CEOs and politicians came to Dubai to pay court to the ruler, whom they treated like a sage.

Sheikh's subordinates competed rashly

Sheikh Mohammed patronized a corps of young technocrats, who worshiped "The Boss" and raced to enact his visions. He told them there was nothing they couldn't do if they put enough imagination and energy into it. When Mohammed Alabbar, the chairman of developer Emaar Properties, came to the Sheikh with a plan to build a skyscraper in what was becoming the new downtown of Dubai, the ruler urged him to build the tallest building in the world. That's exactly what Alabbar did; today the Bourj Dubai is nearly completed, soaring above an artificial lake that boasts an elaborate set of fountains that cost $250 million. For a relatively small place, Dubai has acquired an extraordinary collection of futuristic towers—some of them unfinished or empty. The cityscape looks like something out of Buck Rogers.

A man in a hurry, Sheikh Mohammed created rival building arms and investment managers and spurred them to compete with each other for land and capital. At one point he had at least three private-equity operations going at once under his aegis. These units invested heavily outside of Dubai at the top of the market, using borrowed money. Banks, too, bought into the Sheikh's vision, or at least wanted to be included in the charmed circle.

When the credit crunch came, Dubai was badly exposed to known debt of $80 billion to $90 billion, and possibly even more. The Sheikh and his lieutenants, who had seemed masters at selling Dubai to the world, suddenly seemed inept. That Dubai has a serious problem has been well known for more than a year. Little progress has been made to resolve it.

It almost seems as if the ruler and those around him are in denial, not wanting to acknowledge the extent of their troubles—even to themselves. Earlier this year the ruler appointed a frank-speaking young finance minister, Nasser al Shaikh, who tried to force some of Dubai's big companies to sort out their problems. He was promptly fired.

A mystery: Abu Dhabi's $10 billion

In another sign of stress earlier this month, Omar bin Sulaiman, the well-regarded governor of the financial center, was also ousted. Three of the Sheikh's closest advisors were removed from the board of the Investment Corp. of Dubai, which manages the government's stakes in some of the big companies such as Emirates Airline. These moves may have been designed to appease critics in Abu Dhabi and Dubai's own worried merchant community.

Worried backers of Dubai always assumed that Abu Dhabi would come to Sheikh Mohammed's rescue if he got into real trouble. That has been true to an extent. Earlier this year the central bank of the United Arab Emirates, which is mostly funded by Abu Dhabi, the wealthiest of the emirates, loaned Dubai $10 billion. What has happened to the money is something of a mystery.

This all came to a head on Nov. 25, when Dubai rocked world markets by announcing that it would seek a standstill on debt repayments of ports operator and real estate developer Dubai World, the most troubled of state-controlled Dubai Inc. companies. The timing was horrendous, coming on the eve of an Islamic holiday, as well as the U.S. Thanksgiving. Worried investors—who only recently had begun putting new money into Dubai on the presumption that the worst was over—scrambled for information. Little was forthcoming. Reporters raced around the city, chasing press conferences that were never held. In a bizarre statement on Nov. 26, Sheikh Ahmed bin Saeed Al Maktoum, a Dubai official, said: "The government is spearheading the restructuring of this commercial operation in the full knowledge of how the markets would react."

What prompted the Dubai leadership to behave this way? There has been much speculation that an increasingly sceptical Abu Dhabi had refused to come to Dubai's rescue. But Abu Dhabi appears to have been blindsided by the debt gambit. Only hours before, two Abu Dhabi banks agreed to subscribe to $5 billion in Dubai bonds. Dubai's conduct looks more likely to stem from a combination of lack of awareness and denial, which may well be making things worse than they need to be for Dubai and its ruler.

What happens now? Abu Dhabi will come under pressure to provide more help to avoid being tarnished by a meltdown next door. Sales of Dubai's overseas assets, such as New York clothier Barneys, may be accelerated to raise funds. Sheikh Mohammed will try to preserve his independence and dignity. But already—in what some interpret as a sign of Abu Dhabi's growing influence—Sheikh Khalifa, that nation's ruler, is now pictured with Sheikh Mohammed on a huge poster at a traffic circle in Dubai.
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