Dubai, the Arabian city state that tried to turn itself into Manhattan-on-the-Gulf inside a decade, looks this weekend as if it may end up more like an expensive imitation of Sodom and Gomorrah. No brimstone, no vengeful God, but still an awful lot of wreckage after an orgy of hedonistic excess.

This, until last week, was the world capital of greed, a Legoland of lolly, where flashy malls, artificial islands, and preposterous skyscrapers were run up in no time; where monied chancers booked into £4,000-a-night hotel rooms; and where celebrities who didn't know better were lured into a place that was even gaudier than their own homes. People said it was all built on sand, but, after the businesses at the core of the Dubai empire revealed a black hole of $80bn, we now know it was actually built on debt, semi-slave labour and the glossiest puffery that borrowed money can buy.

This, before we get down to the juicy details, is not how Gordon Brown saw it. The Dubai dream was largely the creation of the late Sheikh Maktoum and his successor, the current ruler Sheikh Mohammed. The day before Dubai's shock debt announcement, the sheikh was in London. According to UAE's national news service, Gordon Brown said he was "impressed with the quick recovery made by the UAE economy and the measures made by the leadership and government there that led to minimal impact of that crisis on the country's economy".

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Once upon a recent time, this was true. At the height of Dubai's property bubble, developers competed to outdo each other and impress the sheikh with more and more outlandish projects at the city's annual property show Cityscape. Ski fields in the desert and the world's largest shopping mall of 1,200 shops, complete with an aquarium housing 400 sharks, are among the projects already built, and plans for an underwater hotel.

Prospective buyers would queue for hours for the chance to purchase off-plan property. Ten minutes later they would sell on to someone at the back of the queue for a £10,000 profit.

While the economy boomed, the city partied hard. Dubai quickly became a favourite playground for Russian gangsters, Bollywood movie stars, and British footballers and their WAGs. David Beckham and Michael Owen were among those splashing out on multimillion-pound properties on the Palm, while Brad Pitt and Denzel Washington were also rumoured to have homes there.

Paris Hilton made a version of her reality show in the bars and malls of city this year. On any given night, parked out front the Grosvenor Hotel, with its popular bars, would be an eye-popping collection of the most expensive sports cars. "Soon," one sheik was quoted as saying, "every Count of Monte Cristo will be in Dubai. In 10 years, only rich and famous people will live here." And the servants? "I would hope robots or clones will do all that by then."

With Western cash came Western cultural norms. Though foreign residents need a liquor licence to drink in their own homes, alcohol is widely available in hotel bars. All-you-can-drink brunches where expatriates got sloshed on champagne became the favoured way of passing Friday afternoons. While the Muslim community spent the holy day at the mosque, Westerners drank themselves legless.

It was at one of these infamous brunches that two Britons fell foul of the strict laws that govern the state. Michelle Palmer, 36, and Vince Acors, 34, who had met for the first time that day, were sentenced to three months in prison in July 2008 after being arrested for having sex on the beach. Not long after, British women Marnie Pearce and Sally Antia were jailed for adultery after their husbands told the police they were having affairs. Yet Arab men will drink openly in hotel bars and prostitution is rife.

The Burj Dubai, the world's tallest skyscraper at 818m, disappears into the clouds high above this emirate of contradictions. Dubai is an architectural odyssey, yet an urban planner's worst nightmare which employed, until recently, 50 per cent of the world's largest cranes. The people of the more sedate and richer emirate of Abu Dhabi 70 miles down the road have often been said to shake their heads at the money its neighbour has wasted. Abu Dhabi's developments such as the breathtaking Yas Marina Circuit used in this year's Formula One championship have been carefully planned.

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Dubai has simply built bigger and bigger with little thought given to planning. It was bound to fail: no city or region could sustain such growth – particularly as the oil that drove that expansion has been slowly running out. The financial crisis simply exacerbated the long-term structural problems of its economy. Last week's announcement that Dubai World, the developer of the famous man-made Palm Jumeirah island development that can be seen from space, wanted a standstill on its repayments on a chunk of its $60bn indebtedness shocked the financial markets. Banks in London and Edinburgh, such as HSBC and the Royal Bank of Scotland, had lent Dubai World billions of pounds. Now there is the very real possibility that they will lose much of this as Dubai World defaults.

On the Palm, on the Persian Gulf's man-made coastline, is the Atlantis Hotel, an imposing construction of two towers linked by a bridge. Kylie Minogue sang at its star-studded opening last year, with spectacular fireworks visible for miles – a one-night jamboree that cost £20m. Dubai World could not have chosen a worse time to open the seven-star hotel.

Attracting Western tourists has been one of the pillars of Dubai's gross domestic product growth, but as Westerners tighten the purse strings so Dubai's tourism industry has started to wobble. The fear now is that the dreams of Sheikh Mohammed could turn into an economic nightmare for both the emirate and the rest of the world. Economists are analysing whether this is the disaster that will create a so-called W-shaped recession – that is, two collapses rather than just the one of a V-shape.

It might seem extraordinary that a tiny emirate of about 1.5 million people could cause such global turmoil, but Dubai is intertwined with some of the most everyday parts of the UK economy alone. Dubai World owns P&O, the ferry operator, while Dubai International Capital (DIC), the state's international investment arm, has a 20 per cent stake in the company that runs Madame Tussauds, the London Eye and the Sea Life Centres.

The reciprocal nature of the UK and Dubai economies means that British firms are now coming to the rescue. The Independent on Sunday can reveal that Dubai World's big lenders, led by the UK-based institutions, have lined up the London-based financial restructuring team a accountants KMPG to salvage the $30bn-plus they are owed. A formal appointment is expected this week.

They will have their hands full.

Gulf state's holdings: Small sample of Dubai's global reach

Millions of dollars have been invested in Sheikh Mohammed's passion: thoroughbred racehorses. In Newmarket, he owns Dalham Hall stud farm and Godolphin stables. The sheikh's 4,000 acres in Ireland make him the largest farmer in the country. He also owns 7,000 acres of paddocks in Britain and 5,000 acres of farmland. Other assets owned by Dubai investors include:

* The QE2, currently moored in Cape Town

* The Adelphi on the Strand and the Grand Buildings in Trafalgar Square

* A 20 per cent stake in Cirque du Soleil, the Canadian circus troupe

* Budget hotel chain Travelodge

* A stake in Merlin Entertainments, which runs Alton Towers, Madame Tussauds and the London Eye

* Scottish golf course Turnberry

* Chris Evert tennis clubs in the US

* A ski resort in Aspen, Colorado

* A 21 per cent stake in the London Stock Exchange

* Ports and ferries group P&O