October 15, 2008 – 11:35 am

The credit crunch swept over Iceland like a cold tsunami, shutting down the country’s largest lender, Kaupthing Bank, crashing the national economy and threatening to bring down the government. Witness:

The cost of insuring against a default by Iceland’s government and the three banks has surged to a record, credit- default swaps show. Glitnir, Kaupthing Bank hf and Landsbanki Islands hf have the worst creditworthiness among European lenders, according to the swaps.

“The focus now is clearly on Iceland as a country risk,” said Mikko Ayub, Helsinki-based head of investment product sales at Nordea Bank AB.

That action led to the three day closing of Iceland’s stock market, and an ensuing 77 percent cliff dive on reopening. But the weight of the government’s full faith and credit is not nearly enough to restore investor confidence. Instead, Iceland must now either beg for relief or become isolated.

Under a currency swap agreement, Iceland on Tuesday, Oct. 14, secured 200 million euros ($270 million) from each of the central banks in neighboring Norway and Denmark, but talks to secure a much larger loan from Russia continued. Icelandic officials arrived in Moscow on Tuesday for talks, though Geir Haarde, Iceland’s prime minister said the size of any loan from Russia had not been decided.

The implosion of Iceland’s largest banks has forced the government’s hand while weakening its bargaining position. This is the worst of both worlds; British and Russian bankers are on the way.

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