Iceland is the metaphor for the whole nasty credit binge and crunch. It will be the first country to go bankrupt as a result, either directly or defacto.

The financial and economic stats tell the real story. The Icelandic Government took control of the country’s biggest bank, called Kaupthing, overnight. The next two banks in importance, Landsbanki and Glitnir, are in receivership. The Government bailed out Glitnir at the start of last week with a $US1 billion deal for a 75% stake: it handed the bank over to the regulators who sacked the board and senior managers on Wednesday with the government saying its problems were much worse than expected.

And we should get another thing straight. Claims from Iceland that the UK Government’s move to freeze British bank deposits in Icelandic banks caused a bank to collapse are not strictly accurate.

Far from it. The reality is that Iceland is the world’s biggest Ponzi scheme, supported by ignorant authorities, a population that preferred to turn a blind eye, venal bankers and lenders, ably supported by greedy depositors in Britain and businessmen and brokers in that country, Scandinavia and the US, with a strong supporting effort from the UK Premier League and its media mates.

Britain’s use of anti-terror laws to protect the assets has certainly raised the odd eyebrow among bankers and lawyers in London looking for work. But the Government acted because Iceland refused to guarantee the 4.5 billion pound of deposits taken in the UK through Iceland’s offshore banks (800 million for local government alone!).

But Iceland is guaranteeing Kaupthing’s domestic deposits and helping manage the banks to provide a functioning domestic banking system, according to Iceland’s Financial Supervisory Authority in a statement on its Web site.

The Government shoved up interest rates earlier in the year to try and stabilise the situation and the krona, but to no avail. Instead, a sharp slowdown emerged with gross domestic product contracting by almost 4% in the March quarter of this year, compared with the December 2007 quarter. Growth in that quarter was barely positive.

The size of the accumulated imbalances are astounding: the external deficit was 25% of GDP in 2006 and 17% in 2007. Gross short-term foreign debt amounted to 15 times the value of the central bank’s foreign exchange reserves at the end of 2007, or roughly 200% of GDP. Gross long-term foreign debt amounted to another 350% of GDP.

Bank assets were running at 10 times GDP by the end of last year. All this to buy stakes in companies, soccer clubs and other assets in Britain (such as West ham in the Premier League), Denmark, the US and elsewhere. It is now emerging that many of these stakes were not owned outright, but through financial derivatives called Contracts For Difference, which adds to the leverage involved. When the deals go bad, the losses are much bigger than first thought.

Kaupthing’s UK arm is a broker called Kaupthing Singer and Friedlander and its gone into administration, but not before selling out the stakes of some UK business men it had financed, including Robert Tchenguiz who lost an estimated 1 billion pounds by being forcibly sold out of big shareholders in retailer, J Sainsbury and pubs group, Mitchells & Butlers.

So assessing Iceland as an investment prospect now, would you invest more there, or look at the US, Australia or the UK where there’s guarantee of getting your money back, especially if you invest in Government bonds.

Some of its offshore investments (such as the UK retail chain, The House of Fraser) will make juice and cheap buys for people with money. But there won’t be any favours and the price will be low and the losses high for Icelandic banks and entrepreneurs.

The three banks, but especially Landsbanksi with its Icesave operation and Kaupthing’s Edge business, raised around over 5 billion pounds from UK and Dutch depositors attracted by high rates and solid credit ratings. 420,000 British and Dutch customers, universities, hospitals, councils and even London’s police force invested in deposits (the UK Government forced local government groups to diversify their funding and deposits to protect against concentration of risk!).

The government is seeking a $US5.4 billion loan from Russia but has yet to ask for aid from the International Monetary Fund to help guarantee deposits. But what will that be used for? To recapitalise the banks or to provide a reserve to start meeting the cost of importing food, oil etc? The country has pension funds with a reported value of $US11.8 billion. They were being urged to sell up and repatriate the money.

The great irony is that Iceland has been an emerging basket case all year. By June the stockmarket and the currency were down 30% and yet the ratings group still had it with a AA rating. It’s even single A today, but watch for another downgrade.

And the Government has to find money to finance the import of food, oil and other essentials. Countries survive, just look at Zimbabwe. But a lot of people who enjoyed a great lifestyle and high incomes in Iceland are going to be very poor from now on. Full repudiation of all debts looks as option, and maximising whatever cash reserves are left, anywhere, even under the bed. No wonder the UK Government moved to grab the money.

Peter Fray

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