Do not put Iceland in a debtors' prison

Olafur Ragnar Grimsson, Iceland's president, this week rejected a law settling his country's dispute with the UK and the Netherlands over the sorry Icesave affair. In truth he had little choice: a quarter of this fiercely independent electorate signed a petition against it, a show of defiance no leader can ignore.

The law will now go to a referendum, likely to vote it down. This may teach Dutch and British leaders the limits of what can be achieved with duress, but too late to do anyone much good.

Landsbanki offered the Icesave accounts under European "passporting" rules, which let banks open branches abroad if they satisfy the home country's regulators and take part in its deposit guarantee scheme. But as its October 2008 collapse showed, Landsbanki was exposed far beyond what Iceland's deposit guarantee fund could pay.

In June, the UK and the Netherlands agreed a 15-year loan to the guarantee fund to reimburse their Icesave depositors, but demanded an Icelandic government guarantee for the loan, which would leave taxpayers on the hook for more than one-third of Iceland's yearly output. (The amount actually paid would be less, depending on what can be recovered from Landsbanki assets). Icelandic legislators passed it only after limiting the guarantee to a share of economic growth over the life of the loan. When British and Dutch authorities balked at the guarantee possibly expiring with the debt still unpaid, changes were passed that were acceptable to the creditors - but not to Mr Grimsson or to most Icelanders.

It is hard to fathom the need to make an example of Iceland. For the creditors, the loans are trivial: they sum to €3.9bn, one-hundredth of what the UK alone will borrow this year and next. Neighbourly generosity would cost Amsterdam and London next to nothing.

They are also not innocent victims. British and Dutch banks benefited greatly from the rules. Had they failed on the same scale, it is delusional to think their governments would take on hundreds of billions in debt to rescue foreign savers, and odious to force a weak neighbour to do the equivalent.

From the start, Iceland has been under the gun. Loans from Poland, Nordic neighbours and the IMF depend on successful IMF reviews that in turn hinge on an Icesave solution. A lifeline-grasping application for EU membership is hostage to British and Dutch goodwill.

Landsbanki showed that Europe must reform its rules to achieve stronger common standards. This will not be done by putting Iceland in a debtors' prison.


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