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its capital. The banking system was also vulnerable because of its rapid expansion
and the bursting of the domestic asset price bubble.
The end
The end came quickly. In the otherwise quiet city of Reykjavik, suspicious movements
of government ministers and central bank governors were detected on
Saturday morning, 27 September. On Monday it was explained that Glitnir, the
smallest of the three larger banks, had approached the central bank for help
because of an anticipated liquidity problem in the middle of October. Lacking confidence
in the collateral offered, the central bank had decided to buy 75% of its
shares at a very low price.
Like the banks themselves, the government had claimed for months that all
three banks were liquid as well as solvent, yet when push came to shove it tackled
1 See Gylfi Zoega (2008), ‘Icelandic turbulence: A spending spree ends,’ VoxEU, 9 April.
2 See Willem Buiter and Anne Sibert (2008), ‘The Icelandic banking crisis and what to do about it,’ CEPR Policy
Insight No. 26; and ‘The collapse of Iceland’s banks: the predictable end of a non-viable business model,’
VoxEU, 30 October; also Jon Danielsson, (2008), ‘The first casualty of the crisis: Iceland,’ VoxEU, 12 November.
a pending liquidity squeeze by wiping out the shareholders of Glitnir. Credit lines
were now withdrawn from the two remaining banks. There followed an old-fashioned
bank run on the Icesave branch of the Landsbanki in the UK The
Landsbanki fell when it was unable to make payments to creditors.
The responses were chaotic. The governors of the central bank announced a
4 billion euros loan from Russia but then had to retract the story within hours.
They also decided to fix the exchange rate but without the requisite foreign currency
reserves this was an impossible task so the bank gave up within two days.
One of the governors appeared on television and stated that the Icelandic state
would not honour the foreign debt of the banks without distinguishing deposits
from loans. Telephone conversations between government ministers in Iceland
and the UK appear not to have clarified the situation.3 The British government
then seized the British operations of both the Landsbanki and Kaupthing in
London. The seizure of Kaupthing’s Singer and Friedlander automatically brought
Kaupthing into default. All three banks were now in receivership.
The foreign exchange market collapsed on October 8th. Following a period of
sporadic trading the central bank started to auction off foreign currency on
October 15th. There are plans to let it float again.
The real economy is currently responding to the turmoil; unemployment is rising
and there have been several bankruptcies and many more are imminent. There
is the realisation that not just the banks but a significant fraction of non-financial

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