Dubai's Debt Problem Underscores New Worries over Government Debt in General

Near-term concern about which banks were holding Dubai's debt was probably the biggest factor in the swoon of global markets last week. But Dubai's announcement on Wednesday that it would seek to delay debt payments of its flagship company, Dubai World, also raises concern about other government debt, according to Wharton finance professor Franklin Allen.

Dubai, of course, is one of the seven United Arab Emirates (UAE, whose federal government, based in Abu Dhabi, bailed out Dubai to the tune of $10 billion earlier this year). But there has been no indication by Abu Dhabi that it will back Dubai's current obligations.

"The big problem going forward is concern about whether other governments are going to be able to pay back their debt," Allen says. "This was not purely government debt, but [Dubai World] is a government-owned entity." Dubai's announcement last week led to wider spreads on government debt for Ireland, Greece and Italy, which will require those governments to pay higher yields on their bonds. "There is a lot of debt out there," Allen notes. "Sovereign spreads are widening, so the question becomes, 'Will this trigger a problem with their debt?' There may very well be another [government credit related] event somewhere else in the world."

The financial crisis and global recession have essentially forced many countries to take on ever larger volumes of debt to bail out banks and stimulate their economies. In addition to Ireland, Greece, Italy and the UK, some emerging markets are also in precarious positions, according to Allen.

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