Iceland teeters on the brink of bankruptcy, Iceland

This volcanic island near the Arctic Circle is on the brink of becoming the first "national bankruptcy" of the global financial meltdown.

Home to just 320,000 people on a territory the size of Kentucky, Iceland has formidable international reach because of an outsized banking sector that set out with Viking confidence to conquer swaths of the British economy, from fashion retailers to top soccer teams

A man walks out of a branch of Landsbanki in Reykjavik, Iceland October 7, 2008. PM Haarde warned Monday that the heavy exposure of the tiny country's banking sector to the global financial turmoil raised the spectre of national bankruptcy.

The strategy gave Icelanders one of the world's highest per capita incomes. But now they are watching helplessly as their economy implodes, their currency losing almost half its value, and their heavily exposed banks collapsing under the weight of debts incurred by lending in the boom times.

"Everything is closed. We couldn't sell our stock or take money from the bank," said Johann Sigurdsson as he left a branch of Landsbanki in downtown Reykjavik.

The government had earlier announced it had nationalized the bank under emergency laws enacted to deal with the crisis.

"We have been forced to take decisive action to save the country," Prime Minister Geir H. Haarde said of those sweeping new powers that allow the government to take over companies, limit the authority of boards, and call shareholder meetings.

A full-blown collapse of Iceland's financial system would send shock waves across Europe, given the heavy investment by Icelandic banks and companies across the continent.

One of Iceland's biggest companies, retailing investment group Baugur, owns or has stakes in dozens of major European retailers, including enough to make it the largest private company in Britain, where it owns a handful of stores such as the famous toy store Hamley's.

Kaupthing, Iceland's largest bank and one of those whose share trading was suspended last week to stop a huge sell-off, has also invested in European retail groups.

Thousands of Britons have accounts with Icesave, the online arm of Landsbanki that regulators said was likely to file for bankruptcy after it stopped permitting customers to withdraw money from their accounts Tuesday.

To try to wrest control of the spiraling situation, the government also loaned $680 million to Kaupthing to tide it over and said it was negotiating a $5.4 billion loan from Russia to shore up the nation's finances.

The speed of Iceland's downfall in the week since it announced it was nationalizing Glitnir bank, the country's third largest, caught many by surprise despite warnings that it was the "canary in the coal mine" of the global credit squeeze.

Famous for its cod fishing industry, geysers, moonscape and the Blue Lagoon, Iceland last year won the UN's "best country to live in" poll, with its residents deemed the most contented in the world.

A branch of Iceland's Landsbanki Bank in Reykjavik October 6, 2008. The country's market authority took control of Landsbanki. Russia would provide a loan of 4 billion euros ($5.44 billion), the Icelandic central bank said.

No more.

Despite sunny skies Tuesday after three days of unseasonably cold weather, Reykjavik's mood remained grim, cafes were half-empty, real estate agents sat idle, and retailers reported few saleir acquisition wallets were filled by a stock market boom and a well-funded pension system.

Back home, the average family's wealth soared 45 percent in half a decade and gross domestic product rose at around 5 percent a year. But the whole system was built on a shaky foundation of foreign debt.

The country's top four bcing its debts, such as the more than $5.25 billion racked up by Kaupthing in five years to help fund British deals.

Iceland is unique "because the sheer size of its financial sector puts it in a vulnerable situation, and its currency has always been seen as a high risk and high yield," said Venla Sipila, a senior economist at Global Insight in London.

The krona is suffering in part from a withdrawal by a falloff in what are called carry trades, where investors borrow cheaply in a country with low rates, such as Japan, and invest in a country where returns, and often risks, are higher.

After watching the free-fall for several days, the Central Bank of Iceland stepped in Tuesday to fix the exchange rate of the currency at 175, a level equal to 131 krona against the euro.

Haarde said he believed the measures had renewed confidence in the system. He also was critical of the lack of an Europe-wide response to the crisis, saying Iceland had been forced to adopt an "every-country-for-itself" mentality.

He acknowledged that Iceland's financial reputation was likely to suffer from both the crisis and the response despite strong fundamentals such as the fishing industry and clean and renewable energy resources.

As regular Icelanders begin to blame the government and market regulators, Haarde said the banks had been "victims of external circumstances."

Richard Portes s were reckless," said. "Quite the contrary. They were hugely unlucky."