Lorna Davidson and her husband Mike gave up Leicester for Dubai this summer looking for a better life. They didn’t find it. The marketing jobs they thought they had in a property firm were withdrawn the day after they arrived and they cannot find alternatives. Nor can they get a mortgage to buy a flat.

“We were told we had jobs at 25,000 dirhams (£5,000) a month and that we could get a property with a 10% deposit,” said Lorna, 24. “There are no jobs and the banks won’t lend without 40% upfront.”

It’s of little comfort to the Davidsons that they are not alone. After a few months when oil-rich Middle Eastern states seemed immune to the effects of the banking crisis and the global economic slow-down, the credit crunch has crashed on to the biscuity shores of the Gulf with the force of an economic tsunami.

With struggling local banks being bailed out, liquidity drying up, the property market transformed from a bazaar of eager buyers into a den of sellers, and the government creating a crisis committee to tackle the slump, observers are asking: is the Dubai bubble bursting?

“Confidence has collapsed,” said Mustafa Alani of the Dubai-based think tank, the Gulf Research Center. Chris Dommett of John Charcol Dubai, a mortgage advisory firm, added: “People have really begun to fear a crash.”

Property, which accounts for almost a third of the local economy and whose giddy rise has fuelled double-digit growth in recent years, is worst hit. Expats living in flagship properties, such as the Palm Jumeirah, the man-made island in the shape of a palm tree, have seen the value of their villas fall by as much as 40% in the past few weeks.

Interest rates on mortgages have on average gone up from 7.5% to 9%, prompting defaults and distressed sales and forcing speculators to dump properties. Banks now demand 40% deposits, up from 10% a few weeks ago, choking off demand from first-time buyers.

Leading developers, Nakheel, Emaar and Damac, which have done nothing but expand since their creation, are slashing staff and putting on hold flagship developments, notably the giant Palm Deira.

The largest bank in the United Arab Emirates, NBD Bank, is so nervous about a property crash that it recently told staff not to grant mortgages to expatriates working for property firms. No wonder the latest joke doing the rounds among expats is: “I knew Dubai wanted to be No 1 in everything. I just didn’t realise that included the No1 boom and bust.”

The view is scarcely rosier from the Emirates Towers skyscrapers in the business district. The stock market has slumped more than 50% this year, wiping out billions of pounds of wealth among retail investors and further constraining liquidity.

Financial services, which account for 10% of the economy, have been hit hard by the credit crunch. Revenue from Dubai’s meagre oil fields has slumped to almost nothing, thanks to the 60% fall in the oil price. And as westerners tighten their belts, the number of high-spending tourists is falling. Khalid Ahmed Bin Sulayem, Dubai’s tourism minister, said last week he was revising downwards his oft-repeated projection of 15m tourists by 2015.

If all that wasn’t enough, there’s a stench of scandal in the air. Leading business executives, including the former minister for finance and chief executive of part state-owned Dubai Islamic Bank, a leading mortgage lender, have been arrested and are under investigation for corruption.

The problem for Dubai is that the quality that enabled it to grow so fast during the go-go years makes it uniquely vulnerable in a downturn. The big property firms and tourism operators, that together account for almost half of economic activity, are largely government-controlled. So are the banks that fund these highly-leveraged companies. In the good times, backing from the city state’s rulers meant free-flowing funds and confidence. Now, in bad times, it means the city state itself is at risk of collapse.

“The companies based in Dubai have become larger than Dubai itself,” said Giyas Gokkent, chief economist at National Bank of Abu Dhabi. “If anything were to go wrong with any of these companies, Dubai does not have the wherewithal to deal with it.”

For now, government and business leaders remain cautiously confident. They point out that all economic crises are relative. Peter Riddoch, chief executive of leading privately-owned property developer Damac, notes that Dubai is still growing, albeit at 6%, down from about 10% last year, and, overall, the UAE has a current account surplus of 22% of GDP.

“The fundamentals are strong,” he said.

Mohammed Alabbar, who runs Emaar and chairs the government’s crisis committee, took the rare step last week of revealing the state of government finances so as to dampen speculation that Dubai might default on loan repayments.

Dubai’s sovereign and corporate debt stood at some $80 billion, he said, compared with assets of more than $350 billion. He dismissed talk of default but conceded times were tough. “We accept the challenges that face us and we will rise to them,” he pledged.

Perhaps. But probably not alone. Dubai may be sinking into financial quicksand but neighbouring Abu Dhabi, the largest of the seven emirates that make up the UAE and the seat of the federal government, remains awash with cash, thanks to its vast oil reserves. It boasts 10% of the world’s known stocks. Most observers assume that if Dubai stumbles, Abu Dhabi will dash to its rescue.

“There may be some schadenfreude on the Abu Dhabi side but they don’t want to see Dubai fail,” said Eckart Woertz, economist at the Gulf Research Center.

Abu Dhabi has already bailed out two Dubai lenders and guaranteed deposits held in local bank accounts to boost the economy.

Bankers from Goldman Sachs, Morgan Stanley, UBS and Credit Suisse are also thought to be putting together a plan for an immediate cash facility to finance Dubai’s $80 billion debt.

The question is: at what price? The last time Abu Dhabi came to Dubai’s rescue almost a decade ago, Dubai successfully fended off demands that Abu Dhabi take stakes in Emirates airline, the Jumeirah Hotels group whose flagship property is the self-styled seven-star Burj Al Arab, and the Emirates Towers business complex. This time Dubai may have to swallow a bitter pill.

Bailout or no bailout, the Davidsons can only wait and hope that things improve. As they search for work, they are moving from floor to floor in friends’ villas and are grateful that the first branch of the budget Premier Inn hotel chain has just opened in Dubai.

“We are trying to look on the bright side but it’s hard,” they said. Like Dubai, they had a dream. Once.

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