Iceland, in Financial Collapse, Is Likely to Need I.M.F. Help

REYKJAVIK, Iceland — Iceland’s financial system collapsed Thursday, and analysts said it was probably only a matter of time before the country would have to turn to the International Monetary Fund (external - login to view) for help.

Such a move, which would make this small island nation the first sovereign state to fall victim to the credit squeeze that began last year, would require it to accept harsh measures to restore fiscal and monetary stability.

Iceland has tried desperately to avoid such a step. But the odds against it grew worse on Thursday when the government took over the last of three major banks and shut down the stock exchange.

Trading in the Icelandic krona ceased, with foreign banks no longer willing to take the currency — even at what seemed like bargain rates.

Adding to Iceland’s sense of isolation, a diplomatic dispute with Britain over money stranded in the failed banks deepened as the British government invoked antiterrorism laws in an effort to get the money.

“Iceland is bankrupt,” said Arsaell Valfells, a professor at the University of Iceland. “The Icelandic krona is history. The only sensible option is for the I.M.F. to come and rescue us.”

Prime Minister Geir Haarde, who had warned this week of the threat of “national bankruptcy,” declined to say Thursday whether Iceland was seeking a rescue package from the International Monetary Fund.

“We will certainly keep this option open, but we have not yet made a decision,” he said at a news conference here.

A fact-finding team from the International Monetary Fund has been in Reykjavik all week, and Mr. Haarde said Thursday that the finance minister, Arni Mathiesen, was on his way to Washington for the annual meeting of the monetary fund and the World Bank (external - login to view) this weekend.

The fund’s managing director, Dominique Strauss-Kahn (external - login to view), said in Washington that he had activated an emergency financing system, last used during the Asian financial crisis of the 1990s, intended to expedite loans to countries in crisis.

“We are ready to answer any demand by countries facing problems,” he said. He did not mention Iceland by name.

Iceland has already approached Russia about the possibility of a 4 billion euro loan to help see it through the crisis, but Mr. Haarde said no agreement had been reached.

The I.M.F.’s intervention in Iceland would underline the extraordinary reversal in the country’s fortunes after a decade-long, debt-fueled binge by the country’s banks, businesses and some citizens. The banks, while avoiding the troubled mortgage securities that have humbled Wall Street, expanded aggressively at home and abroad. When credit tightened and the krona fell this year, they were unable to finance their debts, many of which are denominated in foreign currencies.

In these circumstances, going to the monetary fund “is probably the only thing Iceland can do,” said Richard Portes, an economist at London Business School who has studied the country’s financial problems.

On Thursday, the government seized Kaupthing Bank, the country’s largest lender, effectively completing the nationalization of the banking system after the earlier takeover of two other banks, Glitnir and Landsbanki.

The stock exchange will remain closed until Monday, the government said.

Mr. Haarde acknowledged that international trading in the currency had essentially ended. Bloomberg News cited traders at Nordea Bank as saying the last quoted value of the krona had been 340 to the euro — less than half what the Icelandic currency was worth at the start of the week.

Mr. Haarde said Thursday the central bank of Iceland had set up a special system to handle currency transactions, so that Icelandic companies could conduct international business.

“There are hiccups in the foreign exchange market,” he said. “If not today, then tomorrow, there will be more trading in the currency.”

Sounding surprisingly unworried for the leader of a country facing economic and financial disaster, he said, “We are gradually moving through this crisis.” He added, “There are still a few issues to resolve, but that is the nature of these kinds of things.”

Analysts say the problems with the krona have been at the core of the government’s inability to control the crisis. Without a viable currency, it is not possible to support the banks, which have done the bulk of their business in foreign markets. There is also no way to bring down inflation or interest rates, both of which were already in double digits before the crisis intensified in recent days.

Mr. Valfells and Mr. Portes said that once the situation was stabilized, presumably with help from the I.M.F., the best course would be for Iceland to give up on the krona entirely and to adopt the euro.

How could Iceland, which is not even a member of the European Union (external - login to view), adopt the single currency?

One option would be to simply peg the Icelandic currency to the euro. In that case, Iceland would also hand over control of monetary policy, including the setting of interest rates, to the European Central Bank (external - login to view).

But fixing the currency to the euro could be difficult for Iceland, given that its central bank probably lacks the reserves to defend such a level if the currency were to come under renewed attack.

That leaves another option: applying to join the European Union and adopting the euro. Because Iceland is already part of the European Economic Area, a looser trading group, it abides by many European Union rules.

Still, such a move would be politically challenging. The conservative Independence Party (external - login to view), headed by the prime minister, has been firmly against it.

The New York Times (external - login to view)

Looks like the IMF might have bought another country. I wonder how long they can keep printing money though?