On 7 October 2008 the global financial crisis spread to Iceland, when the Icelandic government put Landsbanki, the second largest bank by value, into receivership. On 8 October the government took control of Glitnir, the third largest bank, buying a 75 per cent stake for €600m; on 9 October it took control of Kaupthing, its biggest bank. These events triggered off a row between Iceland and the United Kingdom over the losses of UK depositors with the collapsed banks, especially in high interest accounts held with Icesave, an online arm of Landsbanki; Dutch depositors also lost out to a lesser degree. Icelandic funds for deposit guarantee were grossly insufficient to provide cover. The Brown-Labour UK regime actually used anti-terror legislation against a fellow NATO-member to freeze Landsbanki and other Icelandic assets held in the United Kingdom. The UK, and Dutch governments, reimbursed most of their depositors for their Icelandic losses, and claimed the money back from Iceland – UK depositors had lost something of the order of over €2.4 billion, the Dutch over €1.3 bn. This represented a per-capita burden of the order of €12,000 for each of the 317,000 Icelanders, or about €40,000 per household, or roughly 50% of Iceland’s GDP. On this, debt interest would be charged at 5.5% per year – a superb rate of return these days. According to the FT, “A year’s interest equals the running cost of the Icelandic healthcare system for six months.”

The deal was approved by the Icelandic Parliament on a narrow 33-30 vote, but over 60,000 people (some quarter of Iceland’s voting population) raised a petition against it, so that President Olafur Ragnar Grimsson refused to sign legislation and blocked the settlement – an implicit vote of no confidence in the Centre-Left Premier Johanna Sigurdardottir. A referendum will take place before 6 March. “The involvement of the whole nation in the final decision – said the President – is … the prerequisite for a successful solution, reconciliation and recovery.”

Two out of the three opinion polls taken since the president’s decision indicate that the legislation will be rejected in the referendum. Considerable pressure is being placed on Icelandic voters, under threat to lose a $10 billion loan package by the IMF, the EU and Nordic countries, and to see the rejection of Iceland's application to join the European Union, which was submitted last July.

The roots of the Icelandic crisis are in the unrestrained neo-liberal policies followed over the last ten years: the privatisation of the banks in question, their de-regulation, the policies pursued by a former Prime Minister of Iceland both in government and then as governor of the Central Bank, not to mention the responsibilities of British and Dutch regulators faced with inordinately fast growth in the foreign operations of the Icelandic banks. “Since the banks had turned Iceland into a hedge fund, with massive short-term foreign currency liabilities used to finance risky long-term assets, the economy was doomed.” (Martin Wolf, FT, 14 January 2010).

Deposit guarantees at the time of the Icelandic banks' collapse differed across Europe, with different national ceilings (only €22,000 in Iceland); what counts is the nationality of deposit-taking banks, not that of depositors. EU regulations require only that a deposit-guarantee system must be in place with “sufficient resources” to cover deposits, but leaves the central bank’s top up (up to 100% in the Netherlands) to bilateral treaties that neither the UK or the Netherlands have with Iceland. Moreover the Dutch Finance Minister Wouter Bos admitted that deposit guarantees are not designed to cover the case of systemic crises (see Sveder van Wijnbergen, NRC Handelsblad, 12 January 2010). And of course such guarantees are not a claim that can be instantly executed at the request of the depositor or his government, but a credit that can be challenged and tested in courts. It is not by chance that Alistair Darling still has not compensated foreign investors in Northern Rock.

The UK and the Dutch are at liberty to cover their nationals’ deposits with Icelandic banks but – until an agreement with Iceland not only has been signed but has also cleared all the protective hurdles put in place by the Icelandic constitution – they cannot unilaterally and automatically execute their resulting credits towards Iceland. The use of anti-terrorist legislation by Gordon Brown to seize Icelandic assets in Britain undoubtedly damaged Iceland’s credit rating and credibility; it was an outrageous, illegitimate insofar as it had nothing to do with terrorism, crass and aggressive move that backfired, notably the referendum initiative was taken by an Association that called themselves “Icelanders are not terrorists”. If Iceland needed a pretext to have second thoughts about the deal, which it does not, redoubtable Gordon Brown’s use of anachronistic gunboat diplomacy is more than enough.

Iceland is already over-indebted. Its stock exchange fell by 90% in the crisis, the krona has lost more than half its value against the euro since July 2007, and even the IMF reckons that “further depreciation of the currency would not be feasible, as it would raise the debt-to-GDP ratio to 240%. The Icesave deal would have done the same. The country’s ability to pay foreign debts – out of net exports – is limited” (Michael Hudson, FT 13 January 2010). According to an OECD economic survey (September 2009) between 2007 and 2010 Iceland's real consumption will have fallen by almost a quarter and domestic final demand by almost 30 per cent. Iceland can invoke customary provisions for "onerous debt". A renegotiation of the original settlement with the UK and the Netherlands would be in the interest of creditors as well: claiming the impossible is bound to result in obtaining less than if a more modest but feasible claim was put forward.

The same bullying tactics – not to say blackmail – that pushed Ireland into ratifying the Lisbon Treaty in last year’s referendum under threat of losing all kind of EU subsidies, are now being used to bully Iceland. Wouter Bos threatened an EU boycott and International Monetary Fund blockade, and a Dutch director of the IMF, Age Bakker, announced that all aid already committed to Iceland would be delayed – a decision that is not his to take but for the IMF Board of Directors, within which he would have to abstain on this issue because of his evident conflict of interest. This is a further disgrace, for neither the interests of Ireland nor those of the EU, or the interests of global financial stability, are changed by a jot with the settlement of a relatively small claim (by EU and IMF standards) with or without a dispute – a settlement which will have to be negotiated, or ruled upon in the European Court of Justice, but either way will be resolved in due course. There is no legal or moral case, and – more to the point – it is not in anybody’s economic interest, to imprison Icelanders in their own country for debt.

'Lord' Myners, the UK Financial Services Secretary, has said that if the deal with the UK and the Netherlands is rejected in the referendum, voters would “effectively be saying that Iceland does not want to be part of the international financial system” (Martin Wolf, cited). It is true that after the President’s decision Fitch has already downgraded Iceland debt to junk status (though not other rating agencies, who have refused to aid the pressure), but it is up to the Icelanders to decide at what price they want Europe and access to international finance. Not unnaturally Icelandic support for joining Europe has decreased significantly since the dispute: by last September a Gallup poll showed that 48.5 per cent now were opposed and only 34.7 per cent in favour. Support cannot have improved since then. The threat of not joining the EU might be treated by Icelanders as a welcome promise.

There are only two redeeming features of this particular Icelandic saga. One is Iceland’s small size. Small is not only beautiful, it is also economically manageable and digestible. €3.8 billion is chump change these days. Which offers the main, probably only ground left for hope in Latvia.

The other piece of good news is that, at the end of last October, McDonalds announced the closure of its three outlets in Iceland and said that it had no plans to return. This was due to the “very challenging economic climate” and the “unique complexity” of its operations (i.e. importing most ingredients from Germany at rising costs, with the Economist’s Big Mac Index still making the krona very much over-valued). Such a privilege for Iceland is shared with only Albania, Armenia and Bosnia and Herzegovina in Europe. A high price to pay for exclusivity, but a privilege nevertheless.