Darkness is falling on Dubai's golden era

What could be damaged is Dubai's ability -- and by extension, that of other local governments in the Persian Gulf region -- to raise money at the competitive prices they have become accustomed to for real estate and other development projects.

These are nations where the distinctions between government, ruling family and government-owned entities are often difficult to discern, where clan ties can help acquire virtually open-ended credit, and where bankruptcy and finance laws are not well tested.

In Dubai's case, "one could in fact argue that the state is its corporations," Woertz wrote.

Government-owned companies such as Nakheel have done well selling their bonds in part because of the perception that oil and clan wealth stood behind them -- an "implicit guarantee" that helped raise the tens of billions of dollars needed to turn Dubai, which lacks the oil resources of its neighbors, into a regional hub for shipping, a playground for the world's elite and a sort of aspirational suburb for hundreds of thousands of Southeast Asian workers.

Officials in Dubai -- and, more significantly, in Abu Dhabi, with which it is federated in the United Arab Emirates -- have now made it clear that there is no such guarantee in practice.

Dubai may well have the cash to pay the bond due on Monday, as well as others coming due in the near future, said Jean-Francois Seznec, a Persian Gulf expert at Georgetown University's Center for Contemporary Arab Studies. But the downturn is so deep and the recovery for Dubai so uncertain, he said, that Mohammed bin Rashid al-Maktoum, Dubai's emir, wants to spread the pain outside the country.

Nakheel devalued its holdings recently and posted a loss of roughly $3.5 billion for the first six months of the year.

Maktoum "wants investors to realize that the total debt of Dubai is a huge amount for a small state," by some estimates well over 100 percent of gross domestic product, including the government proper and government-owned companies, Seznec said. "He wants to put the banks and the hedge funds in the frame of mind that they will have to take a haircut."

As of Sunday, the markets seemed to be predicting a negotiated deal. Stock indexes were higher in the region, and the price of the Nakheel bond had been moving up before trading was suspended last week.

If the bondholders choose to fight, it could be a messy feud, likely challenging tenets of Islamic finance in London courts, and hinging on whether Dubai -- even as it disavows the debts claimed by bondholders -- seeks sovereign protection for assets held abroad by its companies. Nakheel's debt was set up to be governed by British law, under which bondholders could stake their claim. Though the bond was to be used to develop property in Dubai, Nakheel's parent company, Dubai World, owns an array of ports, hotels and other assets around the globe that investors could try to collect against.

And when the next proposal comes along -- to wrest hundreds of miles of beachfront from the sea or build a mile-high skyscraper -- the promises from the government may have to be more explicit, or the cost of borrowing that much higher for Dubai.

"The whole question of implicit guarantee has been thrown into doubt massively," said one local analyst who spoke on the condition of anonymity because of the sensitivity of the issue.