Irony on the Street
A lesson in Economics 101.

By Thomas Sowell

There was a real irony in the recent intervention by the Federal Reserve System to provide the money that enabled the firm of JPMorgan Chase to buy Bear Stearns before it went bankrupt. The point was to try to prevent a domino effect of panic in the financial markets that could lead to a downturn in the economy.
The irony is that it was almost exactly 100 years ago — 1907, to be exact — that the original J. P. Morgan arranged a bailout of a troubled financial institution for the same purpose of preventing a panic that could end up with the whole economy declining.

The difference is that J. P. Morgan and his fellow bankers used their own money, while the Federal Reserve System used their power to create money.

What that means is that the value of your money and my money — all Federal Reserve Notes — goes down when more Federal Reserve Notes are issued to subsidize the purchase of Bear Stearns by JPMorgan Chase.

It wasn’t really a bailout because the stockholders of Bear Stearns lost their shirts. But the firm of JPMorgan Chase got money from the government to seal the deal.

In other words, we all paid to keep Bear Stearns out of bankruptcy, whether we all realize it or not. Whether that was better than the alternative is a separate question — and one whose answer may never be known.

But the big difference between this year’s rescue to stabilize the financial markets and that 101 years ago is that this year’s government rescue leads to demands that still more rescues — including real bailouts — should be extended to homeowners and others.

Back in 1907, nobody could demand that the original J. P. Morgan bail out more people with his own money. But whatever the government does sets a precedent and causes more special interests to demand that they get the same treatment.

There is another irony in this situation. There was no Federal Reserve System in 1907. That is why Wall Street bankers like J. P. Morgan had to do their own heavy lifting with their own money.

Somehow that did not sit right with the Progressives of that era who, like today’s liberals, seemed to think that things should not be left to the market when the government can step in and make everything right.

Such thinking led in 1914 to the creation of the Federal Reserve System.

Unlike other countries, the United States had gotten along for generations without a central government bank. But President Woodrow Wilson thought that the monetary system of the country was too important to let private bankers play such a large role as J. P. Morgan had played in 1907.

Describing the Federal Reserve System created during his administration, Woodrow Wilson said: “It provides a currency which expands as it is needed and contracts when it is not needed.”

The power to expand and contract the currency was “put into the hands of a public board of disinterested officers of the Government itself.”

Their task was to prevent financial panics, bank failures, and a catastrophic contraction of demand. It sounded wonderful — and such sounds count for a lot in politics.

In reality, however, the biggest financial panic in American history occurred under the Federal Reserve System in 1929, followed by thousands of bank failures and an unprecedented contraction of the money supply by one-third during the Great Depression of the 1930s.

There is no question that the people who run the Federal Reserve System today are a lot more knowledgeable about economics than those who ran it back in the days of the Great Depression. Indeed, the average student who has passed Economics 101 today is probably more knowledgeable than those who ran the Federal Reserve System back during the Great Depression.

Being a disinterested government official does not mean that you know what you are doing. That fact gets left out of the equation in a lot of proposals for new government programs.

Financial regulation

Paulson the plumber

An ambitious plan to mend America’s cracked system of financial regulation

MUCH of it will take the best part of a decade to see the light of day, if it ever does. Even the short-term recommendations face a rocky path to implementation. Yet a plan unveiled by America’s Treasury on Monday March 31st is an important first salvo in a fight over the future of financial regulation in the world’s biggest capital market.

The review began a year ago in response to fears about America’s waning financial competitiveness. Then came the mortgage-inspired credit crunch and a host of new problems. The result is a hybrid document—albeit a keenly argued one—that emphasises agency consolidation, while advocating deregulation in some areas and new rules and institutions in others.

The system could certainly be slicker. Its important features date from the 1930s and subsequent changes have lacked any over-arching vision. Supervision of banks, brokers and derivatives is divided up among half a dozen agencies (in contrast to Britain where a super-regulator, the Financial Services Authority, oversees the entire market). Dozens of state regulators sit beneath them. Turf wars are common, duplication rife. Even those who run the agencies use words such as “antiquated” and “dysfunctional”.

The answer, reckons the Treasury, is to redraw lines. It suggests creating three new regulators, one to keep an eye on overall market stability, a prudential regulator for banks, thrifts and credit unions, and a business-conduct agency to oversee disclosure, consumer protection and the like.

The last of these would weaken the Securities and Exchange Commission (SEC), America’s main markets watchdog. The SEC would be merged with the Commodity Futures Trading Commission, which regulates futures, and the combined body would adopt the latter’s principles-based approach (the lawyer-heavy SEC, by contrast, likes to write and enforce rules). It would then take on bits of other agencies to become the business-conduct super-regulator.

Responsibility for market stability would fall to the Federal Reserve, whose role would be greatly expanded. Until now, the central bank has had only a portion of the banking system under its supervisory wing. It would get the authority to inspect institutions of all stripes in order to build a picture of overall systemic risks, and the power to insist on corrective action. It would also win wide-ranging powers to look at the books of investment banks that borrow through its discount window—an arrangement it was forced to introduce last month as Bear Stearns tottered.

The Treasury believes that several other changes—some related to the crunch—can be pushed through more quickly. It wants a mortgage-origination commission created within a few months. This federal body would oversee state licensing of mortgage brokers and underwriters, awarding grades to be used when packaging loans into securitisation pools. The poor quality of such debt is at the root of the mortgage crisis. Another suggestion is to give insurers, currently regulated state by state, the option of a federal charter. State oversight is costly and has stymied the development of national products.

Some types of financial firm that have until now escaped regulation would be brought into the fold, including hedge funds and private-equity firms. But Hank Paulson, the Treasury Secretary (and, as a former boss of Goldman Sachs, sympathetic to industry concerns), stresses that while such firms would be expected to provide more information, there is no plan to wrap them in red tape. Regulation, he believes, can never be a substitute for market discipline. Still, some on Wall Street are worried. Investment banks’ capital requirements are likely to rise, making it harder to get the stellar profits they enjoyed before the latest crash.

These moves are already proving controversial—a sign of political and inter-agency battles to come. Why is the Fed being given such an important role when it failed to spot the dangers in the credit bubble that burst last summer or to act on predatory mortgage lending, ask some. The Fed itself could be forgiven for worrying about being handed the task of spotting crises in advance, a feat that this time eluded some of the most sophisticated banks. The head of the Office of Thift Supervision, which will disappear in the revamp, is stirring up opposition to the Treasury plan.

Tellingly, Barack Obama, the front-runner for the Democratic nomination, was quick to label the plan as inadequate. By the time Congress and the next president are done with it, it is likely to look a lot less punchy. Mr Paulson’s chief aim is to streamline the system. He says wants regulation to be better, not necessarily more pervasive. But many others want to roll back the deregulation of the past two decades. For better or not, they have plenty more debating to do.

Paulson's April Fool's Joke Is Wall Street Gift: Susan Antilla

Commentary by Susan Antilla

April 1 (Bloomberg) -- Seriously, it wasn't an April Fool's Day joke.

Treasury Secretary Henry Paulson presented his plan for regulatory revolution in Washington yesterday, releasing a 212- page ``Blueprint For a Modernized Financial Regulatory Structure.'' After the biggest financial meltdown since your great-grandfather stood in bread lines, Paulson mostly proposed that the markets be less regulated.

Depending upon which broadcast/print/Internet outlet you use to get your news, you might have thought that just the opposite had happened. Words like ``sweeping'' are, well, sweeping the coverage. Promises of the biggest changes ``since the Great Depression'' are peppering the commentary.

And maybe all of that is so. The problem, though, is that this big historical change is such a gift to Wall Street that its leaders can barely contain their glee. The overhaul proposals amount to a ``thoughtful and sweeping plan,'' said Tim Ryan, president of the Securities Industry and Financial Markets Association, or Sifma, in a statement Friday, when a draft of the report began to circulate. Sifma ``intends to be an important player'' in the multiyear process of modernizing the U.S. regulatory system, the statement said.

It's no surprise that Sifma is making itself heard. Sifma and other financial-industry lobbyists have been sharing their proposals on how to fix the U.S. regulatory system since last fall, when the Treasury Department sought comments on the subject.

Into the Abyss

Considering the mess the industry has gotten us into, you would think Paulson's final product might incorporate ideas from those who warned that we were headed into the abyss, not the players who helped push us over the edge.

Yet the final product reads like a very early Christmas gift to the people who run hedge funds, brokerage firms and private equity funds. The financial industry put together its wish list in letters to Treasury in November, and Santa Paulson delivered.

Sifma, for example, recommended in a letter on Nov. 21 that the Securities and Exchange Commission merge with the Commodity Futures Trading Commission, and that the merged entity follow the ``principles-based'' regulatory approach favored by the CFTC. (Wall Street can't get enough of this principles approach, in which mushy concepts such as ``management responsibilities'' and ``prudential supervision and enforcement'' are pushed.)

Presto, Paulson yesterday suggested both the SEC/CFTC merger and a shift to ``principles'' in U.S. regulation.

Cozy Up

The Financial Services Roundtable, a lobbying group of leaders at 100 large financial companies that also backs the principles idea, called for ``optional chartering,'' which would let national insurance companies opt out of state regulation in favor of federal oversight. Yesterday, Paulson proposed an ``optional federal charter'' in his speech. The Roundtable said that it applauded Paulson. And why shouldn't it?

It's all so cozy that the Managed Funds Association -- a lobbying group for hedge funds --- wrote to Treasury that its version of principles-based regulation would encourage a ``cooperative, not combative'' relationship between business and regulators. Don't you just have visions of Steve Schwarzman and Ben Bernanke bursting into a verse of ``Kumbaya?''

Financial companies weren't the only entities to relay their thoughts to the Treasury Department about how to go about a regulatory overhaul. Among those who wrote, though, they appear to have been the most successful at getting what they wanted. Consider the feedback that Treasury received from the Consumer Federation of America, a Washington-based lobbying group whose ideas were invisible in the final report.

More Breaks

CFA sent a proposal to Treasury asking that the regulatory process be more independent of the institutions being regulated and that there be a ``meaningful redress mechanism'' for consumers who were victims of fraud or deceit. The Treasury blueprint proposed the opposite.

Paulson's proposal would give the industry even more leeway to police itself, including making it easier for self-regulatory organizations such as the Financial Industry Regulatory Authority (Finra) to change or create rules without soliciting public comment or getting SEC approval. It also seeks to use self-regulation in new areas, recommending that financial advisers, who are now overseen directly by the SEC, regulate themselves just like brokers do.

Paulson didn't address the issue of consumers with complaints about fraud, but he almost didn't have to. Apart from Treasury's plan to better regulate the mortgage business, the philosophy behind the report was one of streamlining regulations in a way that would benefit the financial industry, not consumers.

No Lawsuits

The financial industry has provided its feedback on redress, though. In its November letter to Treasury, Sifma said that while it was pushing for a principles-based system, it would want to be sure that any change wouldn't ``increase the litigation risk experienced by financial firms.'' New principles to follow, but no lawsuits when you ignore them.

Critics aren't confident that Paulson's blueprint has what it takes to help regulators tackle problems before they become crises. Barbara Roper, director of investor protection at CFA, says she agrees with Paulson on one matter: today's financial crisis wasn't caused by a flawed regulatory structure. It was, she says, the result of ``regulators whose mindless belief that the market is always right made them deaf to warnings of risks'' and blind to the risks that securitization was spreading all over the place, not reducing them.

Paulson told us that we need a strong financial system for ``working Americans.'' Yet his focus is on helping firms like Goldman Sachs Group Inc., the one he used to run, have an easier time of it. When is the public going to say that enough is enough?

As Dubai Millionaires Multiply, Money Masks Missing Liberties

By Simon Clark

April 1 (Bloomberg) -- From his air-conditioned office on the seventh floor of one of Dubai's twin Emirates Towers, Pakistani tycoon Arif Naqvi surveys the metropolis that made him rich.

To Naqvi's left, about 50 skyscrapers rise above the desert city, where thousands of cranes work on $200 billion of real estate projects, according to HSBC Holdings Plc, Europe's largest bank. Sprawling to his right are the palace, gardens and stables of the emirate's ruler, Sheikh Mohammed bin Rashid al- Maktoum, his wives and children.

``I couldn't have done a 10th of what I've done if it hadn't been for Dubai,'' says Naqvi, 47, who moved to Dubai in 1994 with $50,000 of savings and now runs buyout firm Abraaj Capital Ltd. His $5 billion of assets include stakes in Turkish hospitals, Saudi Arabian pharmacies and a Jordanian aircraft repair company. Successful investments include Dubai's Arabtec Holdings PJSC, which is building the world's tallest skyscraper, Burj Dubai, on a $20 billion construction site not far from Naqvi's office.

In a ditch near the Giorgio Armani-designed hotel on the tower's lower floors, construction worker Omkar Singh leans on a shovel and wipes sweat from his brow. Singh, 24, went into debt to pay 60,000 rupees ($1,500) -- more than six months of earnings, including overtime -- to an agent to get to Dubai from India. The agent promised eight-hour workdays. Singh says he works at least 10-hour shifts, six days a week. ``I was taken for a ride,'' he says.

`Come to Make Money'

Dubai's Sheikh Mohammed, who turns 59 this year, has imported freewheeling capitalists and low-wage laborers to transform his sandy realm into the financial, tourism and transport hub of the Middle East. In a region better known in the West for exporting oil and terrorism, Dubai's attractions include an income tax rate of zero and free-trade zones where foreigners can own companies outright, without local partners. The immigration frenzy has raised fears of a real estate bubble and drawn accusations of human-rights abuses.

Foreigners are welcome in Dubai -- as long as they share the sheikh's capitalist vision. ``People come here to make money -- that's the strength of Dubai,'' says Essa Kazim, chairman of Borse Dubai Ltd., which controls the emirate's two stock exchanges. Kazim, 46, wears the traditional white flowing dishdasha gown, white headdress and leather sandals.

Foreigners Outnumber Locals

The emirate has attracted 1.34 million foreign residents as money from oil costing about $100 a barrel flows across the region and into its banks, real estate and government-owned investment funds. They outnumber locals by about nine to one, according to the Dubai Chamber of Commerce & Industry.

In 2006, 6.1 million tourists visited Dubai compared with 8.6 million who went to Egypt, the land of the pyramids, according to the World Tourism Organization. To accommodate them, Dubai is building a new airport complex that the country projects will be the world's largest when it's completed in 2012.

Hundreds of companies, from U.S. private equity firm Carlyle Group to Goldman Sachs Group Inc., the world's biggest securities firm, to Citigroup Inc., the biggest U.S. bank, and Microsoft Corp., the world's largest software maker, have set up Dubai units. David Lesar, chief executive officer of U.S. oil services company Halliburton Co., relocated last year to Dubai from Houston.

``Looking at a map, the major oil and gas reserves are in the Eastern, not the Western hemisphere, which is the main reason for the move,'' Halliburton spokeswoman Melissa Norcross says.

`Singapore of the Middle East'

``It's the Singapore of the Middle East,'' Mark Mobius, who oversees about $47 billion at Templeton Asset Management Ltd. in Singapore, says of Dubai. The emirate offers free movement of capital and confidential banking to locals and people from larger nearby countries such as Saudi Arabia and Iran, Mobius says.

``Singapore's success is based on that,'' he says. ``I have quite a lot of faith in Dubai.'' Templeton, a unit of San Mateo, California-based Franklin Resources Inc., uses Dubai as a base to sell mutual funds in the region.

Under Sheikh Mohammed, Dubai's biggest companies have bought stakes in London-based Standard Chartered Plc, Mumbai- based ICICI Bank Ltd. and New York-based hedge fund Och-Ziff Capital Management Group LLC. Borse Dubai, which already owns about 20 percent of London Stock Exchange Plc, in February bought Nordic stock exchange OMX AB in partnership with Nasdaq Stock Market Inc. for about $5 billion.

12 Stocks

Dubai has a steep hill to climb before it can become an established financial center like New York or London. Its new international stock market, the Dubai International Financial Exchange, lists just 12 companies.

``Dubai has yet to prove itself as a serious locus of capital markets,'' says Ian Hay Davison, the first chairman of the Dubai Financial Services Authority. Davison, 76, says he was fired in 2004 after he criticized proposed trading licenses for local firms that he says didn't meet international standards. DFSA spokeswoman Angharad Irving-Jones declined to say why Davison was fired.

The construction boom is helping ignite inflation, which reached 10.9 percent in the United Arab Emirates as a whole last year, according to National Bank of Abu Dhabi PJSC. The number of new luxury buildings has sparked talk of a real estate bubble. ``I'm skeptical that there is real end demand for all the luxury housing,'' says Eckart Woertz, a Dubai-based analyst at Gulf Research Center. ``On the other hand, people are moving in, and you never know a bubble until it bursts.''

Human Rights

Dubai has also drawn criticism from human-rights activists. ``Dubai is denying basic rights of the laborers who are building the city to organize and collectively bargain,'' says Joe Stork of New York-based nonprofit Human Rights Watch. ``Many are paying off crazy loans in what is a form of indentured servitude.''

Sheikh Mohammed declined to comment for this story through Mona al-Marri, a spokeswoman at Dubai-based public relations firm Jiwin.

Visitors asking questions instead of making money can get into trouble with the police, as Syed Ali, an assistant professor of sociology at Long Island University in Brooklyn, found when he went to Dubai to interview locally born foreign professionals for a book about their lives in Dubai, where they have no rights to citizenship or permanent residence.

On Oct. 22, 2006, Ali, an American Muslim and former Fulbright scholar, was preparing to leave the emirate when five men in white dishdashas and a female officer in regular police uniform arrived with a court order written in Arabic. Ali, 39, says they searched the house he was staying in, confiscated his laptop and iPod and took him to a police station, where he was interrogated for about 13 hours. He says a police officer told him his research was creating divisions in Dubai's society.

`Surprise'

``It really surprised me,'' Ali says. ``Dubai is such an open place socially, it never occurred to me that my work would cause concern.''

Ali, who left Dubai two days afterward, says he later complained about his treatment in an e-mail to Dubai's police chief, Lieutenant-General Dhahi Khalfan Tamim. ``You are welcome to come back at any time as a visitor but not to carry out security-or authority-sponsored research,'' Tamim wrote back in a January 2007 e-mail, a copy of which Ali provided. ``The legal procedures in the case of Mr. Syed Ali were totally in compliance with U.A.E. laws,'' Dubai police Brigadier Khalfan K.A. al-Muhairi wrote in an e-mail to Bloomberg News.

Melting Pot

Sheikh Mohammed created the melting pot of nationalities that Ali wanted to research to boost the value of his most abundant natural resource: desert real estate. Dubai, lacking the giant oil reserves of larger emirate Abu Dhabi, wants to add 882,000 workers by 2015 to boost its economy to $108 billion, almost triple its 2005 size, according to a government strategic plan published last year.

Dubai's oil and gas, which will run out in about 25 years, generated 5.1 percent of gross domestic product in 2005, according to the strategic plan. That compares with about 56 percent in Abu Dhabi. In 2005, manufacturing accounted for 13.1 percent of Dubai's economy, while services including construction, finance, tourism and transport accounted for 73.6 percent.

The relative lack of oil has made Dubai more reliant on debt to fund its expansion. Government debt, mainly loans to state-owned companies, totals 41.8 percent of gross domestic product in Dubai compared with 2.9 percent in Abu Dhabi, says Farouk Soussa, an analyst at Standard & Poor's in London.

``The debt position is still very controllable,'' he says. ``It's driven by a policy to force the government companies to fund themselves and compete with each other.''

`Arab Success'

Dubai is the second-largest of the seven sheikhdoms in the U.A.E., a federation formed in 1971 in which Sheikh Mohammed is the unelected prime minister and vice president. Bordering Saudi Arabia to the west and facing Iran across the Persian Gulf to the north, the area was known to Europeans as the Pirate Coast until local sheikhs signed peace treaties with Britain in the 19th century. While suicide bombers persecute Iraq to the northwest, Dubai has evaded attack.

``Dubai is an Arab success story,'' says Yasser el- Mallawany, chairman of EFG-Hermes Holding SAE, Egypt's biggest investment bank. One of Sheikh Mohammed's government holding companies owns 25 percent of EFG-Hermes. ``The ruler had great vision,'' el-Mallawany, 47, says. ``He managed to create a model to attract the business community to use Dubai as a base.''

Risks

Dubai's reliance on business and tourism rather than oil makes the threat of terrorism more of an economic danger there than elsewhere in the Persian Gulf region. One of Dubai's main resources is people, Soussa says. ``Terrorism could cause them to flee,'' he says.

The Sept. 11, 2001, hijackers, two of whom came from the U.A.E., transferred funds to the U.S. through banks in Dubai, from where accomplices helped them book flights and hotels, according to the 9/11 Commission Report.

Rising inflation also hurts Dubai's appeal to foreigners. ``Inflation raises the cost of living for the expats that Dubai needs to attract,'' Soussa says.

Dubai's Indian laborers, lacking cost-of-living raises that are given to government workers, are finding conditions tough. The U.A.E. dirham, which is pegged to the U.S. dollar, fell 10.9 percent against the Indian rupee in 2007, shrinking the amount workers can send home to their families. ``Prices are very high, and it's getting difficult to stay,'' says Azher Hussain, an Indian with a degree in mathematics who supervises laborers including Singh, the ditch digger.

`Bubble Gum Factory'

The property market in Dubai may be overpriced, Mobius says, adding that Middle East petro-riches would likely cushion any decline. ``I look at the Dubai real estate market and think there could be a bubble,'' Mobius says. ``The difference with Dubai is that they have a lot of money to withstand that.''

Adel al-Shirawi scoffs at the idea of a real estate collapse. ``The way people talk about bubbles, it's like we were a bubble gum factory,'' he says. On a December evening, he parks his black BMW 750Li to admire the cityscape of Dubai under a shining crescent moon. Al-Shirawi was CEO of mortgage lender Tamweel PJSC until Jan. 31. He's now vice chairman of Istithmar World, a government-owned investment company. Tamweel's shares rose 69 percent in 2007 on booming mortgage demand.

``Dubai has increased the value of the desert,'' al-Shirawi says. ``With towers,'' he adds, ``we are selling air.''

Buying and Selling

Dubai's residents can buy and sell 24 hours a day. Khalid Dadoush, a manager at luxury car seller Al-Habtoor Motors Co., tells of one particular late-night order as clients who are test-driving Bentleys roar past him at the Dubai Autodrome.

``It was 9:30 in the evening and my CEO rang to say we have to deliver a Bentley Azure to a VIP customer who was driving by the showroom and had phoned to request delivery,'' Dadoush, 56, recalls. ```Tomorrow morning I don't want it! It has to be tonight,' he told my CEO. We delivered the car around 11:30 that evening.''

Spending starts upon arrival in Dubai. ``Welcome to the Future,'' declares a poster in the airport arrivals area, where residents and visitors stock up on duty-free whiskey, vodka and cognac. Few restrictions are imposed in the name of Islamic law, which prohibits alcohol and prostitution.

Sex is openly for sale in Dubai, even though prostitution is illegal. On a December evening, Julia, a 33-year-old Lithuanian, perches on a stool and sips a $20 mojito at Vu's bar on the 51st floor of the Jumeirah Emirates Towers hotel. She asks $550 for the night. ``I don't go with Arab men, so the police aren't a problem at all,'' she says. Dubai police didn't reply to e-mailed questions on their prostitution policy.

Dubailand

Among the dunes and palm trees of Dubai's desert, billboards tout future tourist sites. ``Dubailand Going Live in 2010,'' promises one sign, referring to a $64 billion plan to cover 107 square miles (277 square kilometers) with 45 mega projects with attractions like the Tiger Woods Dubai golf resort and the Restless Planet dinosaur park. Bawadi, a $54 billion Las Vegas-like strip, will contain 51 themed hotels with 60,000 guest rooms -- and no gambling.

Eventually, such projects will fill almost every developable corner of the 1,500-square-mile emirate, which is smaller than the U.S. state of Delaware. In December, preliminary work started on the Arabian Canal, an $11 billion, 75-kilometer (47-mile) inland waterway. To handle the anticipated influx of visitors, Dubai plans to spend $33 billion to build the complex that will include a new international airport, which will be able to handle 120 million people a year.

Manmade Islands

The reshaping of Dubai continues offshore. Burj al-Arab, a luxury hotel shaped like a billowing sail, juts 280 meters into the Persian Gulf. It overlooks Palm Jumeirah, the first of three palm-shaped islands where Britons including soccer star David Beckham will jostle for beach space with German, Indian and Iranian neighbors when the delayed project is finished. Villas sold for $1.2 million in 2002 can change hands for as much as $7 million, according to real estate broker CB Richard Ellis Group Inc.

Four kilometers off the coast lies the World, a man-made archipelago shaped like a map of Earth. Its 300 islands are made with 320 million cubic meters (419 million cubic yards) of sand vacuumed from the sea floor by dredgers and sprayed into position using satellite technology.

Half of the World's islands, which cost from $15 million to $50 million each, are already sold, says Aaron Richardson, a redheaded Englishman who's a spokesman for property developer Nakheel PJSC. ``Australasia was bought by a Kuwaiti hotel group. A Chinese businessman bought Shanghai,'' Richardson says. Next, Nakheel plans to build the Universe, inspired by the shapes of the solar system.

Legal Landscape

Dubai has also transformed its regulatory landscape, carving out special areas -- legal oases -- where federal laws that prevent majority foreign ownership of companies are invalid. Dubai Internet City is the base for Cisco Systems Inc. and Microsoft.

To attract banks, the emirate set up the Dubai International Financial Centre, a free trade zone opposite the twin Emirates Towers across a busy intersection that has groomed green borders. Foreigners in Ferraris and Porsches zoom past buses carrying exhausted laborers.

In and around a 73-meter-high office tower resembling Paris's Arc de Triomphe, bankers from Credit Suisse Group, Merrill Lynch & Co. and Goldman Sachs hunt for deals. They can litigate under common law and trade Mondays to Fridays on the dollar-denominated Dubai International Financial Exchange.

``If you really want to attract foreign multinationals and investment and banking, you need modern, world-class legislation,'' says Habib al-Mulla, a lawyer and former chairman of the DFSA.

`Briefcase Banking Over'

Dealmakers covering the Middle East no longer have to fly in from London. ``Briefcase banking is over,'' says Swiss-born Ricardo Honegger, 47, who moved to Dubai in 2005 to head Deutsche Bank AG's global markets in the Middle East. ``The financial center gives security of mind to people unfamiliar with the models used in Saudi Arabia, Kuwait or Bahrain.'' The Dubai International Financial Centre's investment unit bought 2.2 percent of the German bank last year.

Jorma Korhonen, who manages about $5 billion of global stocks for Fidelity International in London, says it took him more than eight weeks to open an account to trade local shares in Dubai on its separate exchange for local stocks. ``The old, original exchange remains extremely documentation-heavy by global standards,'' Korhonen says.

Pearl Diving History

Dubai has been a business center of sorts for centuries. Pearl diving and trading with India and Zanzibar, now part of Tanzania, on Africa's eastern coast supported Dubai's economy into the 20th century, Istithmar's al-Shirawi says. His grandfather sailed the Indian Ocean in a wooden dhow, trading pearls plucked from Gulf oysters. ``Dubai has been the hub of people moving back and forth,'' al-Shirawi says.

In the 1950s and 1960s, oil and gas were discovered in the emirates. Around the same time, Sheikh Mohammed's father, Sheikh Rashid, dredged Dubai's creek to encourage trade from shipping.

Sheikh Mohammed, who attended Mons Officer Cadet School in Aldershot, England, started his government career as head of Dubai's police force in 1968, according to his Web site. He was appointed minister of defense in 1971, the year the sheikhdoms gained independence from Britain. In 1977, he took responsibility for Dubai's airport. Eight years later, he started Emirates, today the largest Arab airline. He was appointed crown prince in 1995, the same year he created the Dubai Shopping Festival to boost tourism. He became ruler of Dubai in 2006 following the death of his brother, Sheikh Maktoum.

Dubai Abroad

Under the sheikh, Dubai companies have expanded abroad. Emaar Properties PJSC, the largest publicly traded real estate company in the Middle East with a 66.7 billion dirham ($18.2 billion) market value, has projects from Morocco to India. In Saudi Arabia, Emaar is building an entire city: The $26.6 billion King Abdullah Economic City will cover 65 square miles of Red Sea coast.

At home, Emaar is developing the $1.1 billion Burj Dubai. Project director Greg Sang, a New Zealander, says the tower's final, now secret height will be more than 700 meters. ``Keep the mystery, keep interest in the project,'' Sang says.

Marketing is so important in Dubai that locals even see benefits in the U.S. Congress's high-profile rejection of DP World Ltd.'s 2006 bid for the six American port terminals of London-based Peninsular & Oriental Steam Navigation Co. on security grounds. ``The media was a positive,'' Istithmar's al- Shirawi says. He says the controversy helped boost brand recognition for both Dubai and DP World.

Global Acquisitions

Other Dubai companies are reaching for global brands, too. Micky Jagtiani, the Indian founder of Dubai's Landmark Group, a retailer with more than 600 stores from Saudi Arabia to China, has considered a bid for luxury U.S. retailer Saks Inc. with Icelandic investment company Baugur Group Hf. ``Saks is in a segment we are not into, which is upmarket, but we feel there is potential to expand it into developing countries,'' Jagtiani, 56, said in a December interview.

Abraaj Capital's Naqvi is scouring for acquisitions from Morocco in the west to Bangladesh in the east. Naqvi was born in Karachi, Pakistan, and studied economics at the London School of Economics and Political Science. After working at accounting firm Arthur Andersen and investment bank Morgan Grenfell, he moved to Saudi Arabia in 1989 to work for Saudi billionaire Suliman Olayan. By 1994, he'd had enough. His Saudi boss tried to stop him from leaving, Naqvi says. ``You can't give me the job I want,'' he recalls telling Olayan. ``Yours.''

Naqvi's Ascent

Naqvi's big break came in 1999, when his Dubai business development company, Cupola Investments Ltd., led a $116 million takeover of London-based Inchcape Plc's Middle East assets, investing $5 million and paying for the rest with debt, he says. He broke up the logistics and trading company, whose assets included the Spinneys supermarket chain, engineering units and a logistics business whose clients included Hewlett-Packard Co., the biggest maker of personal computers. ``By selling the individual pieces, we realized close to 25 times our original capital,'' Naqvi says.

In 2002, Naqvi's focus on private equity led him to the U.S., where markets were reeling from the Sept. 11 terrorist attacks. Aramex International Ltd., an Amman-based courier and logistics company that traded on the New York Stock Exchange, had lost more than 15 percent of its value as investors dumped shares of companies with risk in the Middle East.

Naqvi and his investors bought Aramex for $65 million, investing $25 million of equity and paying for the rest with debt. They expanded the company through acquisitions in the Middle East. In 2005, they took Aramex public in Dubai, reaping 6.6 times their investment. Since then, its shares have more than doubled.

Big Success

Naqvi scored another big success this past November, when Abraaj sold 25 percent of Egyptian bank EFG-Hermes to state- owned Dubai Financial Group for $1.1 billion, more than doubling its investment.

Private equity is just getting started in the Middle East, Naqvi says. The region sits on 61.5 percent of global oil reserves, according to BP Plc, and it needs $600 billion of new infrastructure, from power and water to roads, Naqvi says. ``We need to create 80 million new jobs in the next 15 years just to keep the unemployment rate constant,'' he says.

Sheikh Mohammed

Naqvi, like all the executives interviewed in Dubai, praises Sheikh Mohammed, whose portrait is everywhere, from roadside billboards to Deutsche Bank's reception area. Most locals say they've seen the ruler driving his white Mercedes sport-utility vehicle.

Kito de Boer, Middle East managing director of U.S. consulting firm McKinsey & Co., says Dubai has boosted Arab self-esteem, even though the Dutch consultant admits the city's economic stratification can seem a bit Orwellian.

De Boer says his wife was on a trip in the desert a few years ago when her driver spied a hole in the fence of an enclosure for desert oryx, a type of antelope. The driver phoned in the problem. ``Twenty minutes later, there's a crackle on the radio, and Sheikh Mohammed is on,'' de Boer says. ``He says, 'I hear that you've got a hole in the fence.'''

The sheikh isn't the only one watching. ``The security forces are excellent,'' lawyer al-Mulla, 45, says.

No Vote

French-born Denis Ravizza says he's so comfortable in Dubai he doesn't worry about any loss of political freedom. ``I don't care about living in a place where I don't vote and I don't decide,'' says Ravizza, 44, the associate dean of Dubai's French Fashion University. ``What they decide for the country is good for me.''

Others say that freedom matters. ``If we are talking about making Dubai the finest city in the world, it needs to be more transparent,'' says Maitri Somaia, 20, an Indian media and communications student. ``I definitely don't feel oppressed, but whatever I say, I frame my sentences very carefully. I have to.''

Dubai controls expatriates through the visa system, expelling the long-term unemployed, says Abdulla al-Karam, chairman of the Knowledge and Human Development Authority, which oversees 137,622 foreign students in Dubai's schools. ``It cleans the system, because of the visa,'' al-Karam says. ``It gives an opportunity, but it also doesn't give room for becoming a bad resident.'' All U.A.E. citizens get free education and health care, and their utilities are subsidized.

`Everyone Is Overstretched'

Even with so many foreigners living in Dubai, finding talent --be it local or imported -- remains a challenge. ``Everyone in the government is wearing at least two or three hats,'' al-Mulla says. ``Everyone is overstretched.''

Al-Mulla says at one time he was a member of the Federal National Council, the U.A.E.'s parliament, manager of his law firm and chairman of the DFSA. ``It takes a very long time to find people,'' says Samir Assaad, a Dubai-based private equity executive at Kuwait's NBK Capital Ltd. ``Sometimes we look at Turkey, eastern Europe and Germany to import management.''

The cheap labor isn't running out for now. Workers live in special camps such as Sonapur -- Hindi for city of gold. Sonapur is hemmed in by a barbed wire fence. On Fridays, its residents play cricket on wasteland between long huts that are bedecked with overalls drying in the sun.

Singh, the ditch digger, says he'll stay in Dubai to pay off his loan and earn cash for his wife and two-year-old daughter in India. ``Now I'm here, I'm going to work until I've got something to show for it,'' he says.

Practicing Religion

After the Arabic mass at St. Mary's Catholic Church, Lebanese architect Nehme Kheyralla pushes through the crowds of Filipinos entering the church for the next mass, which will be held in their own language. He's been saying prayers for his second cousin, General Francois El Hajj, who was assassinated in a car bomb explosion in his homeland two days earlier. The church stands next to a mosque on land donated in 1966 by Sheikh Mohammed's father.

``In the Middle East, Dubai gives the best chance of practicing your religion, staying alive and making some money,'' Kheyralla says. ``It's good when leaders understand the need for diversity.''

As long as he keeps the money flowing, Kheyralla and others like him will be welcome in this capitalist oasis.