People demonstrate against Iceland’s Prime Minister Sigmundur David Gunnlaugsson in Reykjavik, Iceland. (Stigtryggur Johannsson/Reuters)

Iceland may be a small country, but it makes a lot of international headlines. In 2008 it became a poster child for the dangers of rapid financial growth when its hyper-leveraged banking system imploded. Over the next few years, the country became a darling for those looking for hope after the economic crisis, as its economy recovered remarkably quickly. Several Icelandic initiatives drew international attention, including a policy of letting banks fail, a new crowd-sourced constitution and efforts to prosecute financial actors that had contributed to financial calamity.

Now it’s in the newspapers for another reason. Its prime minister has seemingly been forced to resign after the leaked Panama Papers revealed that his family holds funds in offshore shell companies. The political furor shows that Iceland’s recovery is brittle and its underlying social consensus weak.

Here are the five things that explain why Iceland is reacting so strongly to the Panama Papers.

The prime minister publicly proclaimed the strength of Iceland’s national currency while his family kept much of its money elsewhere

Iceland is part of the European Economic Area, but not the European Union’s euro zone. This means that it doesn’t share a single currency — the euro — with other European countries. Instead, it has the Icelandic krona, one of the smallest independent currencies in the world. Monetary independence has been both a blessing and a curse since the crisis. On one hand it enabled Icelanders to impose emergency capital controls and partly manage the devaluation of their currency after the financial collapse. These helped prevent economic disaster and nurturing an early recovery.

On the other hand, it is very difficult to keep a small currency stable in the global economy. The krona’s instability has meant that some Icelanders want the country to join the euro, despite the bitter criticisms of the euro zone’s austerity policies. The outgoing Prime Minister Sigmundur Davíð Gunnlaugsson, in contrast, has been the krona’s strongest advocate. Keeping the krona is at the core of his nationalist populist political platform. This makes it all the more shocking to many Icelanders that his family apparently kept substantial personal funds abroad, which was presumably denominated in foreign currencies.

The prime minister previously refused to step down, claiming his wife's overseas assets were taxed in Iceland and insisted there was no fiscal wrongdoing. (The Washington Post)

The offshore company made claims on the assets of the failed Icelandic banks

The offshore company owned by Gunnlaugsson and his wife — Wintris Inc. — was one of the creditors making claims on the assets of the bankrupt Icelandic banks, asking for a total of about 3.5 million euros. Gunnlaugsson sold his share in Wintris to his wife for $1 in 2009, the day before legislation requiring owners to pay tax on revenue generated by offshores took force.

In 2014 the Icelandic government, led by Gunnlaugsson, negotiated with the creditors of the failed banks on the conditions under which they could remove funds from the Icelandic economy, which was still protected by capital controls. The result was that creditors could either make a negotiated “stability contribution” or else be subjected to a “stability tax” of 39 percent. Before this conclusion was reached the government had indicated that it would subject all creditors to a stability tax. The “estimated revenue from stability contributions was 18-32 percent of GDP while estimated revenue from a stability tax would have been 34-42 percent of GDP. The fact that Gunnlaugsson had interests to protect on both sides of the negotiating table, but failed to reveal his conflict of interest to the public, has caused outrage and consternation.

Gunnlaugsson is not the only offender

Gunnlaugsson led a coalition government composed of his center-right Progressive Party and the right-wing Independence Party. The Panama Papers revealed that a number of other politicians in both parties also owned offshore companies. This includes Finance Minister Bjarni Benediktsson and Minister of the Interior Ólöf Nordal, respectively the chair and vice-chair of the Independence Party. Municipal politicians have also been implicated.

The journalists who broke this story in Iceland have stated that a total of 600 Icelanders appear to have had offshore accounts revealed in the Panama Papers and that they will make further revelations in the coming days. Such revelations will feed into political debate about substantial sums of money that seem to have left the Icelandic economy in the aftermath of the financial crisis. They also raise new questions about what happens to the public interest, given that key members of its political and economic elite may have quietly opted out of the basic social bargain of paying taxes in return for broadly based public services.

The bad press is reminiscent of the days of the financial collapse

The 2008 crisis didn’t just bring economic calamity to Icelanders but challenged their identity. Foreigners stopped associating Iceland with Björk, Sigur Rós and silly stories about elves, and started associating the country with default on debts, International Monetary Fund intervention and disputes with the United Kingdom and the Netherlands over who should pay for failed banks. International media coverage of the Panama Papers, featuring Gunnlaugsson alongside various world leaders of less than impeccable democratic credentials, is bruising national pride again. This is especially problematic for Gunnlaugsson, who had positioned himself as a proud nationalist.

Traditional parties are in big trouble

The center-right government that was in power at the start of the financial crisis was ousted by sustained popular protest. Disgruntled voters then rallied behind the two traditional left parties. They held power for the next four years but became increasingly unpopular over their term in office. Icelandic voters returned the right wing to power in the last elections.

However, it seems likely that the current coalition will be swept out of office on a wave of protest. Prime Minister Gunnlaugsson has already announced his resignation, but this will probably not suffice. The government is unlikely to survive.

Yet the situation now is very different from what it was in 2008. Even though the governing parties are unpopular, left wing parties are in no good position to turn the right’s troubles to their advantage. According to recent polls the largest party, and the only one that enjoys growing popularity, is the Pirate Party. This new party — born out of a rejection of the political status quo and the traditional left-right divide — brings together a heterogeneous collection of candidates who don’t agree on policy but do agree on process. The leader of the Pirate Party (a prominent former WikiLeaks activist) has promised that she will lead a short-term government if elected, to reform politics, bring in a crowdsourced constitution and then dissolve itself. If an election takes place, this group of political mutineers may lead a new government along an uncharted course. Politics will certainly be interesting in Iceland again, but perhaps better observed from a distance.

Oddný Helgadóttir is a PhD candidate in the Department of Political Science at Brown University.