'Nordic Tiger' Iceland Finds Itself in Meltdown

Haarde, in a news conference later in the day, said the government was forced to take the bank over after authorities in London, concerned about protecting the money of hundreds of thousands of British depositors, froze the bank's assets in Britain, effectively rendering it bankrupt.

"We think this is very unfortunate," said Haarde, barely able to hide his anger at Britain's moves. "We were hoping that Kaupthing would be able to survive this crisis."

The foreign depositors had been attracted by interest rates higher than what they could get at home. But it was only this week that many discovered that the Icelandic government guaranteed only the deposits of customers here in Iceland. That led British officials to threaten to sue, and also to invoke a 2001 anti-terrorism law to freeze the banks' British assets.

Icelanders are now talking about falling back on the old industries -- fishing, aluminum smelting, and nature tourism at its spectacular volcanoes and hot springs.

Haarde did not play down the impact on his citizens in the meantime. "This is going to be a very painful process for many people here," he said Thursday. "Many people will lose their jobs. . . . Many shareholders -- probably all of them -- will be losing money, some losing substantial amounts."

"It's going to take years to rebuild the economy up to the standards we have today," said Frosti Olafsson, an economist with the Iceland Chamber of Commerce. ". . . The whole economy is basically on hold now."

One of those unlucky investors, Bjarnason, the business professor, said: "I knew something was going to happen. I didn't know how serious." He also heads an association of small shareholders. Concerning his investments, he said, "I was not cautious enough, even though I am an economist."

For many Icelanders, the hit is compounded by the collapse of the currency. Because of Iceland's high interest rates, banks here sometimes encouraged people to take out loans in low-interest foreign currency to buy their cars or their houses. Now with the krona losing 50 percent of its value in recent weeks, people find themselves owing twice what they borrowed.

Ulfar Steinthorsson, who runs a Toyota import showroom here, said about 15 percent of new-car purchases have been made with foreign loans. Olafsson, of the Chamber of Commerce, said about 7 percent of mortgages might be denominated in foreign currency.

During the Cold War, Iceland, a NATO ally, hosted a large U.S. military base and was known mostly as a European backwater, subsisting largely on its fishing industry and periodically hosting prominent foreigners such as chess masters and President Ronald Reagan and his Soviet counterpart, Mikhail Gorbachev. The two leaders held a summit here in 1986.

When the Cold War ended, the U.S. base closed. After their industry was privatized and deregulated in the late 1990s, Iceland's banks moved to expand beyond their tiny home market. They launched a major overseas expansion into Europe. The result was that Iceland turned into one of the region's wealthiest nations. It ranked first on a 2007 United Nations index of "most developed" countries -- becoming the "Nordic Tiger."

Iceland's problems were heightened by its odd relationship with Europe, not quite in, not quite out. It never joined the European Union, in part to avoid the bloc's fishing regulations, and kept its separate currency but decided to opt into various European economic agreements. "We opened up to the free flow of goods and capital," said Adalsteinn Leifsson, professor and director of the MBA program at Reykjavik University. "But we didn't have the stabilizing effect of the European Central Bank."

As the three big banks expanded, acquiring more and more property and businesses overseas, they far outstripped the Iceland central bank's capacities to regulate them or provide guarantees. "We had become a major banking center like Luxembourg or Switzerland," said Brynjolfsson, editor of Iceland Review. He added, "This is what happens when corporate institutions grow out of proportion to the system designed to regulate them."

On Thursday, the prime minister announced that Landsbanki had been restructured into an entirely new, trimmed-down entity called New Landsbanki that would do business only domestically, turning it from a global giant into a traditional bank. He said he hoped for the same for the two others in the next few days.

Said Reykjavik University finance professor Oddgeir Ottesen, "The Nordic Tiger is not a tiger anymore. It's a kitten."