Arab Emirates Aim to Limit Dubai Crisis in Pledge to Banks

Trying to prevent a run on its banks, and financial turmoil that some fear could spread globally, the United Arab Emirates helped calm financial markets Monday with its pledge to lend money to banks operating in Dubai, an action that came amid concerns about excessive borrowing around the world.

The move by the group’s central bank was an attempt to head off the kind of crisis of confidence that froze credit markets last year and brought the global economy to the brink of failure, threatening everyone from hedge fund billionaires to retirees who had their savings in supposedly safe investments.

Central bankers and government officials around the world were watching Monday’s stock markets closely for signs that fears are spreading or are being contained, and the early signs were positive. Asian markets in their first hours were up more than 2 percent on Monday morning.

Last week, investors fled the stocks of banks with outstanding loans to the tiny emirate and its investment arm, Dubai World. Now, analysts will be watching to see whether investors desert other highly indebted companies.

While Dubai is not big enough to set off financial repercussions outside the Middle East, the main fear is that investors could flee risky markets all at once in search of safer havens for their money. As in September 2008, when the failure of Lehman Brothers heightened worries about all financial institutions, they might pull back, regardless of the markets’ strength.

Those fears were allayed only after the United States announced a huge bank bailout and began guaranteeing a variety of borrowing that slowly helped credit markets begin functioning again. That many of these measures remain in place could help contain any problems from Dubai now.

But while the federation is following a similar strategy, albeit on a smaller scale, analysts expressed concern that the promise of added funds to support Dubai banks might not be enough to keep anxiety from jumping to other countries and institutions.

Indeed, an analysis from Goldman Sachs on Sunday said that the failure of federation authorities to provide a blanket guarantee for all of Dubai’s debt showed that governments worldwide were less willing to bail out overextended companies and their investors.

“This episode represents a timely reminder that emergency public funding support should not be taken for granted,” wrote Francesco Garzarelli, an analyst based in London for Goldman.

The extent to which the federation and its wealthiest member-state, Abu Dhabi, which has vast oil reserves, appear to guarantee Dubai’s debts could affect how investors view many other companies previously believed to have the implicit backing of their governments.

“There are plenty of people around in world capitals who are tired of bailouts,” said Simon Johnson, a former chief economist at the International Monetary Fund.

As a result, banks that made big loans to some heavily indebted governments and companies might start to incur more losses. The shares of HSBC and Standard Chartered, which lent heavily to Dubai, have fallen sharply in the last week, and Mr. Johnson said that the cost of insuring against defaults by big Irish banks has surged since the Dubai announcement.

A fear of contagion from Dubai would further destabilize European banks that were only starting to mend.

The Dubai crisis began last week, when the emirate said Dubai World would not be able to make on-time payments for some of its $59 billion in debt. The company invested in lavish real estate projects, including artificial islands in the shape of a palm tree and a globe, and spent heavily to acquire stakes in glittering properties like Barneys in New York and the MGM Mirage in Las Vegas.

Dubai was far from alone in taking on too much debt as companies and countries around the world did the same. Investors have already been alarmed by problems in countries in Eastern Europe, in Ireland and in Greece.

Dubai’s problems are also a reminder of the lasting effects of the global real estate bubble, which remains a danger in the United States, where several big banks are encumbered by souring commercial real estate loans.

There is a concern that governments have responded to the financial crisis by taking on unsustainable levels of debt that they may no longer be able to finance. Even in the United States, public debt is forecast to rise to around 80 percent, from about 40 percent, of gross domestic product, the economist Nouriel Roubini said.

“Dubai could be the beginning of a series of sovereign debt issues or crises,” said Mohamed A. El-Erian, chief executive of Pimco, the giant bond-trading firm. “What Dubai is going to do is make people think more intensely about the lagging implications of last year’s crisis. It’s going to be a wake-up call to the people who thought that the financial crisis was just a flesh wound.”

Many analysts expect federation authorities to release further details as soon as Monday on how they plan to restructure the debt of Dubai and Dubai World to keep markets calm.

Analysts will be watching crucial indicators of stability or alarm. The most apparent will be if money is pulled from other investments to the safe havens. Analysts will be monitoring the amount of interest that investors demand to lend money to emerging market countries. It has already risen sharply since the Dubai crisis erupted on Wednesday.

A major worry, investors say, is that the global debt crisis in private debt could metastasize into a debt crisis for governments that are running mounting deficits to pay for bailouts and stimulus packages — especially in Eastern Europe but also in Britain.

In fact, a warning sign has already started flashing: the cost of insuring debt issued by Greece, a member of the euro bloc, is now as much as insuring Turkey’s debt, an investment that was once considered much riskier.

One consequence of the global financial crisis is that Greece has been forced to take on shorter-term external debt. Debt securities due within a year have risen to $24 billion in the second quarter of 2009, from $14.5 billion at the end of 2007, according to figures from international economists.

Many countries may face tests in the weeks and months to come as they try to roll over their existing debts. These countries will not be able to raise money easily or cheaply. This could put pressure on stronger members of the European Union to bail out weaker members, or at least help them restructure their debts and nurse them back to health.

So strung out was Latvia this year that the country barely recovered from a speculative attack on its currency, the lat, though it is a member of the European Union. As it teetered, economists fretted about a coming “lat bath,” like the Thai “baht bath” devaluation that set off the 1997 Asian crisis.

The International Monetary Fund, World Bank and European Union stepped in to prop up the weakest countries, however, and fears of true sovereign defaults in Europe’s most vulnerable countries receded before last week’s turmoil. These institutions’ guarantees, however, do not extend to state-backed companies.

Hungary, Bulgaria and the Baltic states of Latvia, Lithuania and Estonia carry foreign debt that exceeds 100 percent of their gross domestic products, Ivan Tchakarov, chief economist for Russia and the former Soviet states at Nomura bank, said in a telephone interview from London.

But the problems, if any, are likely to be limited to Europe. The tremors would not immediately spread to the United States, beyond the effects of the strengthening of the dollar, and potentially a weakening of commodity prices as investors bet on a slowdown in emerging markets.

However, in the long run, a global credit crisis set off by Dubai would make the cost of financing the trillions of dollars in American debt much more expensive, Mr. Roubini said. “Even the U.S. — over time — cannot run forever unsustainable fiscal deficit,” he said. “The total financing needs of the U.S. will range in the $1.5 trillion to $1.7 trillion a year for the next decade,” he said. “That is a huge amount of public debt to issue and or roll over.”