NEW YORK – Dubai's debt crisis rattled world financial markets Friday, raising concerns that some banks could further tighten lending and stall the global economic recovery.
The possible spillover effects centered on fears that international banks could suffer big losses if Dubai's investment arm defaulted on its $60 billion debt. Stock and commodity markets tumbled in New York, London and Asia as investors flocked to the U.S. dollar as a safe haven.
But earlier concerns that the crisis might trigger another financial meltdown seemed to ease after some analysts downplayed the risks for U.S. banks, which are thought to have little exposure to the Middle Eastern city-state.
U.S. stocks fell sharply but rebounded from their lows as investors concluded that the damage might be contained. The Dow Jones industrial average lost about 155 points, or roughly 1.5 percent, in a shortened trading day, and other stock averages also sank. Oil prices plunged as much as 7 percent before recovering some ground later in the day.
"I don't think the collateral damage is going to be that great," said Jeffrey Saut, chief investment strategist at Raymond James. "People will dig into this over the weekend, but I think balance sheets have healed enough to withstand a shock like this."
Still, the crisis in Dubai pointed to the vulnerability of the global economy despite signs of recovery. Last year's credit debacle left major banks with billions in losses, forcing them to reduce lending to consumers and businesses.
Access to credit has improved in recent months, but analysts said Dubai's woes could make some banks more cautious. That could further squeeze lending and weaken the recovery after the deepest recession in decades.
"What we need for the economic momentum to continue is for banks to feel confident about lending, and clearly what has happened in the last 48 hours is not a step in the right direction," said David Williams, banking analyst at Fox-Pitt Kelton in London.
Dubai's troubles caught investors by surprise. A year after the global slump derailed the city-state's dizzying growth, its main investment arm, Dubai World, revealed this week it was seeking at least a six-month delay on repaying its $60 billion debt. Credit agencies responded by slashing debt ratings on Dubai's state companies, saying they might consider the plan a default.
In recent years, Dubai has expanded with ambitious, eye-catching projects like the Gulf's palm-shaped islands and the world's tallest skyscraper in hopes of becoming a tourist-friendly Middle Eastern metropolis. In the process, though, the state-backed networks nicknamed Dubai Inc. have racked up $80 billion in red ink. The emirate may now need another bailout from its oil-rich neighbor Abu Dhabi, the capital of the United Arab Emirates.
In Europe, stock markets rebounded after Wall Street fell less than feared. Earlier, stock indexes in Hong Kong and South Korea tumbled 5 percent in response to the previous day's Dubai-related losses in Europe.
The Dubai crisis caused the dollar to spike higher against the euro and pound but slump against the yen, another traditional safe haven. Speculation that the Bank of Japan might intervene by buying dollars or selling yen to aid Japanese exports helped the dollar recover after it had fallen to a 14-year low against the yen.
European banks appeared to be at most risk if Dubai World can't pay its bills. London-based lenders HSBC Holdings and Standard Chartered could face losses of $611 million and $177 million respectively, according to early estimates from analysts at Goldman Sachs. Both have substantial Middle East operations.
South Korea estimated the country's financial institutions have just $88 million in exposure. Construction firms from Japan, Australia and South Korea behind Dubai's recent development boom also might be on the hook.
Among U.S. banks, Citigroup Inc. had $1.9 billion in exposure to the United Arab Emirates as of 2008, according to a JPMorgan research note. But it's unclear how much of that was related to Dubai. Citigroup declined to comment.
In the U.S., Dubai World owns at least eight office buildings and hotels, including the Mandarin Oriental and W Union Square hotels in New York and the Fontainebleau in Miami Beach, according to data supplied by Real Capital Analytics. Its projects also include Dubai World's and casino operator MGM Mirage's deal to build the CityCenter project on the Las Vegas Strip.
Between October 2005 and April 2008, Dubai World bought 10 U.S. properties for about $9.7 billion, the Real Capital Analytics data showed. Two of those properties, both office buildings in New York, were sold in November 2007 for a combined $2.4 billion.
But Dubai World's problems likely won't have a major effect on the U.S. commercial real estate market, said Dan Fasulo, managing director of Real Capital Analytics.
"They didn't acquire enough," Fasulo said. "They have only been active for a few years."
But the effect on the banking system could eventually touch businesses and consumers. Even if most banks could absorb any Dubai-related losses, the emirate's troubles could lead them to reevaluate and scale back lending. That would make it harder for companies to borrow and to help sustain the global recovery, analysts said.
Others expressed concern that Dubai's woes could stall the buying behind asset booms in emerging markets in Asia and Latin America, which have attracted enormous capital amid investor enthusiasm for regions with rapid economic growth.
"I think it will make investors realize they need to be more discriminating about emerging markets," said Arjuna Mahendran, head of Asian investment strategy at HSBC Private Bank in Singapore.