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March 08, 2010

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So the Icelandic deposit-insurance fund was undercapitalized for the case of total economic collapse. Seems to me that the Iceland authorities compounded the problem by splitting the Landsbanki assets and guaranteeing the onshore deposits in full. If they hadn't done that, the Brits and Dutch wouldn't have anything to complain about.

I'd agree, with two caveats. First, I'm not entirely positive that Anglo-Dutch governments would have let Iceland off the hook even had it let all deposits go hang equally. Icelandics did suffer quite badly, and it didn't produce much sympathy in London or Amsterdam. I take the rhetorical power of the fairness argument, but I don't know if it would have made a difference.

Second, I'm not sure that letting Icelandic depositors go hang was an option. Given how bad things were, having most domestic savings evaporate could have shredded the social contract in ways that I can't imagine. Riots? Revolution? Certainly an election followed by a reversal of that initial decision, I would think.

Yes, election followed by reversal seems most likely result of the go-hang option.

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