The government of Iceland on Tuesday [Oct. 7] took extraordinary measures to try to save a financial system battered by the global credit crunch, saying it had sought an emergency loan from Russia to stave off the threat of "national bankruptcy."
As the credit crunch tightened its grip on this remote island country in the North Atlantic, where a debt-fueled boom has turned to bust, the government took control of a second major bank and pegged the krona to a basket of currencies in an effort to arrest its plunge.
But most surprising was Prime Minister Geir Haarde's decision to ask Russia for a loan of €4 billion, or $5.5 billion, to help the government and the central bank keep the economy afloat.
Though the government initially said it had secured backing for the loan from Moscow, the Russian deputy finance minister, Dmitry Pankin, told the Interfax news agency that no decision had been made. Iceland later acknowledged that it had been premature, saying it had contacted the Russians but had not yet reached an agreement.
The confusion added to the sense of bewilderment here over the speed with which the financial situation has gone from bad to worse.
"We are still in the midst of events unfolding, and it's impossible to see where it's going to end up," said Bjorn Gudmondsson, head of research at Landsbanki, the second-largest bank in Iceland, after Kaupthing.
Landsbanki was nationalized on Tuesday under new powers rushed into force by the government. At the end of last month, the government stepped in to take control of Glitnir, another lender.
"We were faced with the real possibility that the national economy would be sucked into the global banking swell and end in national bankruptcy," Haarde said late Monday.
Concerns about the government's ability to support the banking sector, whose estimated lending is equivalent to almost 12 times the size of the national economy, have pushed the currency into a tailspin. The fall of the krona has pushed inflation into double digits, requiring the central bank to raise its benchmark interest rate to more than 15 percent.
In measures more typical of a developing economy than one of the wealthiest countries in the world, the central bank on Tuesday fixed the currency to a trade-weighted index at the equivalent of 131 kronur to the euro. The bank said it was still working with the government to find additional ways to support the currency "with the aim of quickly reducing inflation."
Gudmondsson said new financing, like the proposed loan from Russia, was essential to help the central bank keep the currency from sliding further. The krona has fallen more than 30 percent against the dollar in the past month.
The central bank said that it had contacted Russia about the loan "some months ago" but the situation had deteriorated so rapidly that a loan agreement became urgently needed.
It said that Russia - where several Icelandic banks have branches - would grant the loan for the next three to four years with an interest rate of up to one-half percentage point above the interbank lending rate.
For Russia, the loan would be a way to show its financial power and willingness to help distressed economies.
"It's a PR stunt to reassert Russia's position in the global economy of the 21st century," said James Beadle of Pilgrim Asset Management in Moscow. "But Russia also has a lot of cash it can't use domestically because of the inflation problem."
In Reykjavik, the government reiterated that all deposits in its banks were guaranteed. But the crisis could reverberate in foreign markets where Icelandic banks have set up branches, luring customers with attractive savings rates.
Customers of Icesave Bank, a British bank controlled by Landsbanki, were not able to access their funds on Tuesday. A note on the bank's Web site did not give any further information. Icesave is an Internet-only bank.
In the meantime, the deposit compensation unit of the British Financial Services Authority on Tuesday was readying application forms for Icesave's 300,000 customers, who have an estimated £2.5 billion, or $4.4 billion, on deposit. Icesave's depositors are partly covered by the British deposit insurance system.
Customers will probably have to wait "a couple of weeks" to receive their savings of up to £50,000, a spokesman at the FSA division said. The British financial watchdog on Tuesday increased the level of guaranteed deposits to £50,000 per account, from £35,000.
In Reykjavik, where the government and bankers are speaking in the most dire terms about the gravity of the situation, ordinary people seem more sanguine about the events unfolding inside the boxy headquarters of Iceland's financial institutions.
"These are difficult times for Iceland," said Karl Savar, a taxi driver. "But the economy is strong. The fishing is strong. People have enough work."
Julia Werdigier reported from London.
Crisis extends to soccer
The global credit crisis touched a London soccer club Tuesday after the Icelandic bank headed by West Ham United's owner was put in receivership, Reuters reported from London.
The Icelandic government said it was taking control of Landsbanki as the country's financial system threatened to collapse and its currency plunged.
The chairman of Landsbanki, Bjorgolfur Gudmundsson, is the owner of West Ham. He led an £85 million buyout of the east London club in November 2006.
Gudmundsson is Iceland's second-richest person, after his son Thor. The Gudmundsson family members are major shareholders in Landsbanki.
West Ham, already reeling from the loss of its shirt sponsor last month after the collapse of the tour operator XL Leisure, said that the club was not for sale and that the owner remained "as committed as ever," in spite of the financial crisis.