Dynamics of Cats

Last week one of Iceland's commercial banks went bankrupt and was nationalized over the weekend.

The root cause of the implosion is that the Icelandic commercial banks overextended aggressive investments and were over leveraged, so when the world economy went bad they got squeezed.
The proximate cause of the collapse is that their primary line of credit was with Lehmans and when it vanished shortly before they needed to renew it, they were blindsided and hadn't lined up alternative lines of credit.
After the fact, of course, no one wanted to lend to them, and they were about to get calls on their bills with no cash - so they were nationalized.

This had two effects: it vapourized almost $2 billion in equity, largely with Icelandic investors, who promptly pulled back cash, and, by associative metaphor, no one wants to lend to any of the other Icelandic banks, because, well, an Icelandic bank failed so all Icelandic banks are now suspect.

But, the Icelandic banks are overextended into Europe - particularly the UK, Baltics and Scandinavia. Lots of aggressive lending and investment and innovative US style finanical instruments.
So... the remaining Icelandic banks are making margin calls on their investment clients and closing their lines of credit, pulling in their cash in anticipation of investor and depositor panics. Premiums for Icelandic credit default swaps have spiked, not that any new bonds are being issued - by spiked I mean 62.5% - not 62.5bp.

So a cascade is triggered, shares are sold to meet margin calls, credit lines are withdrawn and cash evaporates from the system.

Now... the Icelandic banks are probably small enough they won't trigger a European collapse by themselves, though they could possibly be the proverbial straw...

The government of Iceland is acting - there is bailout plan and looking for a large loan to provide liquidity or capital to the surviving banks.
There was open discussion in the Icelandic media today that there might have to be a "bank holiday" - that all banks might close over the weekend, remain closed while exposure to foreign loan and credit was unwound, and the bankrupt institutions nationalized and the remained allowed to reopen. Don't know that it will go that far now or any time soon, but the mere fact that it is under serious discussion is eye opening. I suspect this will depend a lot on whether the other Scandinavian central banks will help intervene, the Norwegian central bank maybe the only institution with that kind of money and the interest in helping.

We're talking about $50 billion, for an economy that is 1/1000th the size of the US.

A more interesting, and somewhat more panicked discussion, was contemplation of the possibility that the government would have to use their foreign currency reserves to secure food supplies for the winter.

Now, Iceland is a major importer/exporter, and a net exporter of food, primarily fish.
A lot staples are imported, especially grain and fruit.
It is also fashion central, if non-essential imports are constrained by currency shortages there will be a major worldwide consumer crunch - I know it is only 300,000 people, but man we buy a lot of crap.
So, if the currency is going to collapse and loans are unavailable, for a while, then currency reserves should be held back for essentials - ie grain and fruit and other essentials not available internally.
Temporarily, unless our export markets collapse and stop buying.

Hey, maybe we can go back to barter - frozen or salted cod for wheat and red wine.
Worked in the 1930s.

Oh, and just to reassure people, the minister for commerce says it is ridiculous to talk about oil shortage - there is a 30 days reserve of fuel oil and petrol in country, and they're sure they can find currency to buy more real soon now.

So, maybe there won't actually be any fish for export either (no ships at sea=no fish).
I wonder if they like salted cod in Dubai?
Maybe Norway will sell us oil.
Please.
Pretty please?