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it could keep its own currency. In that case it should relocate its foreign currency
banking activities to the euro area.
The paper was written well before the latest intensification of the global financial
crisis that started with Lehman Brothers seeking Chapter 11 bankruptcy protection
on September 15, 2008. It does therefore not cover the final speculative attacks on
the three internationally active Icelandic banks – Glitnir, Landsbanki and Kaupthing
– and on the Icelandic currency. These attacks resulted, during October 2008, in all
three banks being put into receivership and the Icelandic authorities requesting a $2
bn loan from the IMF and a $4 bn loan from its four Nordic neighbours.
Policy mistakes Iceland made
During the final death throes of Iceland as an international banking nation, a
number of policy mistakes were made by the Icelandic authorities, especially by
the governor of the Central Bank of Iceland, David Oddsson. The decision of the
government to take a 75 percent equity stake in Glitnir on September 29 risked
turning a bank debt crisis into a sovereign debt crisis. Fortunately, Glitnir went
into receivership before its shareholders had time to approve the government
takeover. Then, on October 7, the Central Bank of Iceland announced a currency
peg for the króna without having the reserves to support. It was one of the shortest-
lived currency pegs in history. At the time of writing (28 October 2008) there
is no functioning foreign exchange market for the Icelandic króna.
In addition, outrageous bullying behaviour by the UK authorities (who invoked
the 2001 Anti-Terrorism, Crime and Security Act, passed after the September 11,
2001 terrorist attacks in the USA, to justify the freezing of the UK assets of the of
Landsbanki and Kaupthing) probably precipitated the collapse of Kaupthing – the
last Icelandic bank still standing at the time. The official excuse of the British government
for its thuggish behaviour was that the Icelandic authorities had
24 The First Global Financial Crisis of the 21st Century Part II
informed it that they would not honour Iceland’s deposit guarantees for the UK
subsidiaries of its banks. Transcripts of the key conversation on the issue between
British and Icelandic authorities suggest that, if the story of Pinocchio is anything
to go by, a lot of people in HM Treasury today have noses that are rather longer
than they used to be.
The main message of our paper is, however, that it was not the drama and mismanagement
of the last three months that brought down Iceland’s banks. Instead it
was absolutely obvious, as soon as we began, during January 2008, to study Iceland’s
problems, that its banking model was not viable. The fundamental reason was that
Iceland was the most extreme example in the world of a very small country, with its

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