Saving Iceland

27.3.2008 | 11:20

By Robert Shrimsley

http://www.ft.com/cms/s/0/e006c43a-fb9f-11dc-8c3e-000077b07658.html?nclick_check=1

Published: March 27 2008 02:00 | Last updated: March 27 2008 02:00

The European Central Bank on Wednesday tore up its own rulebook to bail out Iceland, the giant hedge fund off the west coast of Norway that owns large parts of Britain's high streets.

Although central bankers did not actually believe Iceland was too big to fail, they feared it was too interconnected to be allowed to go down. One official said that top of the ECB's mind was the fear that a fire sale of Iceland would spread contagion across Scandinavia and right into the Woolworths.

As a fund operating outside the eurozone, Iceland would not normally qualify for ECB help but officials have changed the rules to save Europe's financial system.

Iceland's three biggest funds - the Baugur Opportunity Fund; the Glitnir Worth A Punt Fund and the Kaupthing Let's Have a Go Fund - were all highly leveraged, sitting on debt several times larger than Iceland's gross domestic product. As liquidity tightened, Iceland embarked on a desperate search for cash. Its prime minister travelled to China with a bold plan to sell its sovereign wealth fund a 20 per cent stake in the women's wear department of Debenhams.

The signs of distress were already evident; the currency had plummeted in value; credit default swaps had widened sharply on the country's banks and Whittard of Chelsea had all but run out of Café Français.

The ECB therefore opened its discount window to Iceland, allowing it to borrow funds posted against German collateral. As part of the deal Germany gets to annex Iceland for the knockdown price of 2 krona a share - giving it an equity value of $250m - and all but wiping out the country's shareholders.

Investors are said to be furious, claiming that Reykjavik alone is worth $10bn. The deal is an attractive one for Germany, which has long wanted its own pure fish play and now acquires Iceland's prime fisheries unit for next to nothing.

However, the move has enraged Denmark, which claims pre-emption rights over the Iceland fund it ran until 1944. It has threatened legal action unless it is given first refusal over the isle. Officials are now trying to broker a sale and leaseback arrangement under which Denmark leases Iceland to Germany for a nominal sum while retaining its claim.