What a difference a year makes. Only last November, Iceland's status as one of the most successful economies in the West was underlined when it was judged the best place to live in the world.
Iceland had ousted Norway from the head of the UN's league table of 177 countries that compared per-capita income, education, health care and life expectancy – which, at 80.55 years for males, was third highest in the world.
This was only one in a string of glowing assessments of a country (population 313,000) which had pulled off a modern-day economic miracle. No wonder they are also said to be the happiest people on the planet. The inhabitants of this newly discovered Utopia, with its much-admired free health and education systems, bought the most books, owned most mobile telephones per head, and included the highest proportion of working women in the world.
Iceland had also presided over the fastest expansion of a banking system anywhere in the world. Little did anyone know that the expansion once so admired would go on to saddle the country with liabilities in excess of $100 billion – liabilities that now dwarf its gross domestic product of $14 billion.
Iceland overreached itself in spectacular fashion, and the party is coming to a messy end.
Yesterday, trading in the shares of six major financial institutions was suspended as the government sought to avert meltdown.
Sigurdur Einarsson, Chairman, Kaupthing Bank, warned against people being too alarmist.
"Over the years we have built a strong and well-diversified bank. We have some of the strongest capital ratios in the European bank sector. We've got good asset quality and a highly diversified loan portfolio.
Kaupthing has and continues to manage its business prudently and, with our strong fundamentals, we are naturally concerned when we hear malicious rumours and sensationalism about Kaupthing being reflected irresponsibly. We ask people to look at the facts, not rumour and inuendo."
Meanwhile, Icelandic interest rates have been catapulted to 15.5 per cent, peaks not seen in Britain since Black Wednesday, in an attempt to rein in inflation. The krona's freefall on the international currency markets is surpassed only by the catastrophic failure of Zimbabwean currency.
One of the country's three banks, Glitnir, has been nationalised; another wants money from its customers. Foreign currency is running out as international banks refuse pleas to lend money.
No longer smiling, office workers hurry home wondering out loud if they will have jobs to go to by the end of the week. Car showrooms are deserted. Estate agents are closing early. There are few takers for the thousands of unsold houses on their books. An unexpected cold spell is keeping many people inside their homes, another reason why the shops, many of which have discount sales, are quiet.
The speed with which Iceland rose and then fell to earth has bewildered not just the islanders but also Geir Haarde, the Prime Minister who has spent the past four days locked away with his advisers in Reykjavik. He emerged on Monday to announce new powers for the country's financial regulator:
"We were faced with the real possibility that the national economy would be sucked into the global banking swell and end in national bankruptcy. The legislation is necessary to avoid that fate."
The dramatic change in Iceland, from the poor relation of Europe to one of its wealthiest and apparently most successful, and now back again, dates from the mid-1990s with the privatisation of the banks and the founding of the country's Stock Exchange.
The free market reforms unleashed a new generation of thrusting, young businessmen, many of whom picked up their banking trade in the United States. They were determined that their country would no longer have to rely on fishing for its principal source of wealth; they loathed the international perception of Iceland as a parochial nation of farmers and fishermen who could not hold their own on the world business stage.
They had learnt at school all about the last Cod War with Britain, in 1976, when Iceland unilaterally extended its territorial waters, desperate to increase the financial yield from its trawler fleet. So, in keeping with the traditions of their Viking ancestors, the new army of corporate raiders went overseas to seek their fortune.
Kaupthing, one of the three banks at centre of the debt crisis, is not even in the top 100 of the world's biggest banks. But its influence on the British economy is out of all proportion to its 124th ranking. In five years it has underwritten more than £3 billion in debt to help finance British deals.
This is why the bankruptcy is not only adding to the turmoil on London Stock Exchange – which at one point yesterday lost eight per cent of its value – but also sending ripples through the British High Street. Baugur, the Icelandic investment house, has amassed large stakes in retailers including Hamleys, House of Fraser, Oasis, Debenhams and Iceland the frozen food store. Question marks hang over their future.
Kaupthing lent the money to Baugur to finance its investment in Arcadia back in 2001, which it then sold on to the British billionaire Philip Green. It also snapped up the UK merchant bank Singer & Friedlander for £547 million in 2005 – a company which has helped bankroll some of Britain's best known entrepreneurs, such as Gordon Ramsay. It also advised the sportswear tycoon Mike Ashley on his troubled £134 million purchase of Newcastle United football club. Kaupthing was also a big investor in the London property market, which has become another millstone round the bank's neck.
The Icelandic bankers were able to raise billions for their expansion from the booming new Stock Market in Reykjavik and because of Iceland's extraordinary well-funded pension system.
For decades one of the poorest countries in Europe, Iceland could finally celebrate as the average family's wealth grew by 45 per cent in five years. GDP accelerated at between four to six per cent a year and the wealth was invested in property that, in turn, fuelled an unsustainable boom in house prices. In the good times, credit companies sprang up offering 100 per cent loans, many in foreign currency such as Japanese yen or Swiss francs. But with the krona in freefall, some loans have doubled in size and thousands are defaulting.
Some did counsel caution. In 2004, Bjorn Gudmundsson, an economist with Landsbanki, said: "We think the economy will cool rapidly in 2007. Much of the investment in infrastructure will come to an end then." But the dealmakers thought the good times would last for ever. In the same year that Gudmundsson sounded his warning, Icelandic investors spent £895 million on shares in British companies alone.
It was almost inevitable that when the international credit crisis unleashed the worst financial tsunami the world had seen since 1929, there was little that Iceland, which disbanded its armed forces 700 years ago, could do to repel the shock waves. Iceland has guaranteed all its savers deposits, but could not extend this guarantee to the hundreds of thousands of British savers who have invested money in their internet savings banks.
The mood of crisis was heightened further when the Government suspended all public service broadcasting, a measure usually reserved for volcano warnings. The chairman of the opposition left-green party, Steingrimur Sigfusson, has called for a coalition government to lead Iceland through its financial emergency.
The trade unions, meanwhile, are pressing for Iceland to begin talks about becoming part of
the European Union, which the government has been reluctant to join for years. The pension funds have now also agreed to help the Government by selling assets.
It took a while, though, for the penny to drop. As recently as this spring, when questions were being asked about the economy, the country was in denial.
Dagur Eggertsson, a former mayor of Reykjavik, said: "Someone called it 'bumblebee economics' because it is hard to figure out how it flies, but it does, and very nicely, too." The bumblebee, though, like the billionaires who thought they could buy up the British high street, is no longer flying high.
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