Somewhere I've been meaning to visit. Perhaps it might be more affordable now. From the New Yorker's James Surowiecki:
" ... analysts are wondering whether the new Nordic Tiger will end up, instead, as “the Bear Stearns of the North Atlantic.” ... So how did Iceland get in so much trouble? That’s the odd part of the story: it isn’t because its banks gambled on the worthless subprime securities that helped undo Bear Stearns and so many others. Iceland’s banks prudently avoided the subprime market, even as they embarked on a lending boom at home and expanded abroad. What got Iceland in trouble was something more subtle: its banks got their money primarily from international investors, making the Icelandic miracle heavily dependent on foreign capital."
Without knowing anything about Iceland's problems, this sounds like duration mismatch. Of course, this statement is vacuous since the function of the bank is to take short term deposits and lend long term. However, there are degrees of mismatches and banks are aware of how badly they can be mismatched. This was true in the case of Bank of America as documented by Moira Johnston in "Roller Coaster" and Gary Hector's "Breaking the Bank" where bank executives realized that they were in trouble when looking at the numbers, the degree of mismatch and the loan loss provisions were insufficient.
This was surprising:
"Further, the country’s troubles have made it a potential target for speculators seeking to drive down the value of its currency and perhaps cause a run on the banks. In 1998, hedge funds purportedly worked together to attack Hong Kong’s currency and its stock market, an attack that was foiled only when the government bought up a sizable chunk of the stock market. It’s not clear that a similar cabal is gunning for Iceland—the governor of its central bank insists that one is—but the notion is certainly plausible: with a population the size of Pittsburgh and a central bank whose total reserves are less than five billion dollars, the country makes an easy target for hedge funds flush with cash."
And the nugget of wisdom?
"Homeowners default on mortgages in San Diego, and suddenly people in Reykjavík are paying more for gasoline and wondering if their bank deposits are safe. That doesn’t mean that Iceland is an innocent victim. The country went overboard with spending and borrowing—between 2000 and 2007, domestic credit in the Icelandic banking system more than quadrupled as a share of G.D.P. And relying on foreign money to fuel that kind of frenzy is foolish, since it puts you at the mercy of fickle foreign investors. But Icelanders can be forgiven for wondering if they’ve really been any more reckless than many other countries—most obviously the U.S., which relies heavily on foreign capital to fund home buying and profligate consumption, and whose banking system is rife with reckless lending."
Update (October 5, 2008):
Iceland has indeed bailed out Glitnir. But here's the thing: Iceland's credit default swaps are now suggesting that the sovereign itself is a distressed credit.
Contracts on Iceland's debt jumped to 17.5 percent upfront and 5 percent a year to protect 10 million euros ($13.8 million) of bonds.
This is not how triple-A sovereigns behave. It's as though the analysts at Moody's were only able to see one step ahead, and not two: they could anticipate that Iceland would bail out its banks, but they couldn't anticipate that when a tiny country bails out a bank whose assets vastly exceed the country's own GDP, then the sovereign itself loses much creditworthiness. One scary datapoint: the assets of Kaupthing Bank amount to 623% of Iceland's GDP, which is possibly why its own credit default swaps are trading somewhere over 2500bp.