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Iceland is a risky model

The country should not be held up as a model for other peripheral sovereigns to follow.

In late February Iceland agreed to a referendum on the latest deal for the government to assume responsibility for repayments of sums the UK and Dutch governments paid out to compensate depositors in Icesave, the internet arm of collapsed Landsbanki. Any news from Iceland is a reminder that at least one country has already made the stark choice of saving domestic depositors in its collapsing banks while letting the banks’ international bondholders go hang.

The widespread assumption seems to be that Iceland has got away with this and that it deserves to. In late 2008, with food disappearing from the shelves and two of its three big banks facing imminent collapse, the country found itself facing a financial crisis as severe as any developed nation has confronted since the 1930s.

The government passed an emergency law that prioritized the claims of depositors over other unsecured creditors with which depositors had previously ranked pari passu. The banks were restructured, leaving the foreign bondholder and bank creditors to hope for some recovery on the banks’ largely foreign-currency problem assets.

Ever since, the Icelandic government has been locked in sometimes vituperative negotiations with UK and Dutch government deposit insurance schemes.

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