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Is Dubai the First Casualty in a Global Epidemic?

Officially, the only news coming out of Dubai on Sunday was that the central bank of the United Arab Emirates, the seven-state federation of which Dubai is a part, will extend ample credit to banks in Dubai. That should avert a series of runs now that it's pretty clear Dubai's banks have piles of bad loans sitting on their balance sheets.   

But, of course, no one's *that* interested in the local financial sector in Dubai (spectacular though its collapse may be). The really questions weighing on investors' minds are two-fold: 1.) Is the U.A.E--which basically means Abu Dhabi, the federation's oil rich city-state--going to bail out Dubai World, the state-owned company that's in the process of stiffing its creditors to the tune of up to $59 billion? If so, then the story probably ends there for the moment. 2.) Are other countries now struggling under mountains of debt--Ireland, Greece, the Baltic states, Bulgaria, Romania--in danger of defaulting themselves? Which is to say, is there a risk of a global contagion here? This Times piece goes through some arguments on both sides. On the one hand, these countries do have a lot of debt and their interest rates (and the cost of insuring their debt) have been rising since the first Dubai rumblings last week. On the other hand, none of them appear to have borrowed quite as recklessly as Dubai. (Or, at least, Dubai World--remember, it's a government-owned company, but it's debt isn't technically the same as debt issued by the government of Dubai.)

One intermediate possibility could be almost as bad: Investors grow skeptical of debt issued by banks in the aforementioned countries--Ireland, Greece, et al--which makes it impossible for those banks to roll over their debt and effectively collapses these countries' financial sectors. Meanwhile, because the countries are heavily indebted already, they can't bail out their own banks, creating a massive economic crisis. (I alluded to this possibility on Friday.) Not pretty.

Simon Johnson thinks the EU may end up following Abu Dhabi's lead and partially bailing out Ireland and even Greece. (Though he thinks both Abu Dhabi and the EU would impose some losses on creditors--that is, it wouldn't be a 100 percent bail out. He--and I--sees this as a good thing, as long as the markets take it in stride.)