Iceland: The country that became a hedge fund

    The blame game is only just beginning. But it's already clear that Iceland's demise was a result of flawed economic and monetary policy, bungled crisis management, and a calamitous breakdown of international cooperation. Iceland's business and political community bear an important part of the responsibility, even as they now play the victim.

    But others share the blame, including the government of British Prime Minister Gordon Brown, which used controversial antiterrorism legislation to deliver the death blow to Iceland's banks. Other governments, too, adopted an every-nation-for-itself attitude during the crisis that raises doubts about future cooperation among European Union countries.

    For Icelanders, the big question is how they ended up in such a mess. (Even Iceland-born singer Björk has complained about the crisis in the London Times.) For a few heady years they binged on the country's newfound wealth and borrowed heavily to buy houses, fancy cars, and flat-screen TVs.

    Sitting in a café overlooking the pond that divides central Reykjavík, Arnaldur Indridason, the country's leading crime novelist, waves his arm at the idle construction cranes in the distance. "I don't think Iceland realized where the money was really coming from," he says, "or how fragile it all was."

    Iceland used to be one of Europe's poorest countries, a bleak place that survived mostly on fishing revenue and the occasional adventurous tourist who came to bathe in the natural hot springs or explore the moonlike lava fields. Davíd Oddsson almost single-handedly changed that.

    A onetime actor and producer of radio comedy shows, Oddsson, 60, was elected mayor of Reykjavík while in his early 30s and went on to become Iceland's longest-serving Prime Minister, in office from 1991 to 2004. With thick, wavy hair, he's moody, witty, and an outspoken free-marketer who likes to quote Milton Friedman and has modeled himself on Britain's Margaret Thatcher.

    It was Oddsson who engineered Iceland's biggest move since NATO: its 1994 membership in a free-trade zone called the European Economic Area. Oddsson then put in place a comprehensive economic-transformation program that included tax cuts, large-scale privatization, and a big leap into international finance.

    He deregulated the state-dominated banking sector in the mid-1990s, and in 2001 he changed currency policy to allow the krona to float freely rather than have it fixed against a basket of currencies including the dollar. In 2002 he privatized the banks. When he stepped down as Prime Minister in 2004, he did a stint as Foreign Minister before becoming governor of the central bank in 2005.

    Oddsson's policies seemed to have paid off handsomely - for a while. In the decade from 1995 to 2005 the economy recorded annual average growth of more than 5%, far faster than most of its European trade partners, and on a per-capita basis, Iceland amazingly became the world's fifth-richest country. Its fishing industry expanded, and it developed a geothermal energy business.

    But the principal fuel for Iceland's boom was finance and, above all, leverage. The country became a giant hedge fund, and once-restrained Icelandic households amassed debts exceeding 220% of disposable income - almost twice the proportion of American consumers.