Iceland - what happens if nationalization does not help?

The policy of the day is for the government to take on the liabilities of a financial institution to provide liquidity and stability. This policy is based on the premise that the credit quality of the government is not questioned. At worst, the credit quality of the government should be no worse than any institution within the country. The sovereign rating is generally a cap on corporate ratings. However, nationalization is no answer if the liabilities exceed the ability of a country to pay in a timely fashion.

Now we have the case of Iceland. The stock market has been closed and the government has seized control of the largest bank. The entire banking system has been nationalized and domestic deposits have been guaranteed. The government is negotiating a loan from Russia which has significant geopolitical implications.

The debt of the banks is $61 billion or 12 times the size of the economy. The country rating is BBB- and a negative watch. The krona is in free fall and we are now reminded that governments can go bankrupt and sovereign risks are real. Carry trade are over and now we move back to the current account dynamics of whether a country can pay their bills.