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mick silver
18th November 2008, 00:14
As recently as last year, Iceland was considered an economic success story. After 16 years of free-market reforms, it was one of the world's 10 richest and freest countries. Efficiently managing its fish stocks -- elsewhere operated with huge losses -- it also enjoyed a strong pension system. Massive tax cuts had led to strong economic growth and rising tax revenues. At the same time, extensive privatization generated about $2 billion for the state, allowing it to pay off most of its debt. The newly privatized banks were flourishing. Income distribution was relatively even, and the poverty level one of the lowest in Europe. Like other Nordic countries, Iceland was a stable democracy under the rule of law.

Then, in the first week of October 2008, all went wrong. The three main Icelandic banks collapsed and the government took over their domestic branches. It is still unclear what will happen to their foreign operations. The local currency, the krona, went into free fall. Foreign trade came to a standstill, as it became almost impossible to transfer money to and from the country.

Why did the international financial crisis hit Iceland so hard? A plausible answer is that Iceland's banks were oversized: With assets worth more than 10 times the country's GDP, the Icelandic Central Bank simply could not act as their only lender of last resort. In hindsight, Iceland's Financial Supervisory Authority should perhaps have demanded much earlier that financial institutions significantly scale down their foreign operations
http://online.wsj.com/article/SB122695569056034695.html