the failed landsbanki and by general distrust among foreign counterparties. with heavy central bank involvement, international payment flows were gradually restored in the months that followed. i have expanded at some length on the measures taken when the banks failed, as there are still a number of misconceptions about the process. some have claimed that the banks were bis central bankers ’ speeches nationalised. they were not. the old banks are private companies. they are in winding - up proceedings governed by law ; they are not under the control of the government. the government has a majority stake in only one of the new banks. others have claimed that iceland defaulted and got away with it. the opposite is true. the credit of the sovereign was preserved, and all debt obligations have been paid on time. this is why the sovereign was able to tap international capital markets last summer, and why its cds spread is currently around 300 points. before leaving the topic of crisis management and resolution in the case of the icelandic banks, i would like to say a few words about deposit guarantees. why did the government give a verbal blanket guarantee only for domestic deposits and not the deposits in the banks ’ foreign branches? after all, this distinction probably added fuel to the fire of the so - called icesave dispute about the settlement of deposit guarantees in landsbanki ’ s dutch and british branches. the short answer is that such a guarantee would never have been credible. as a result, it would not have stopped the run on these deposits and, if attempted, might have bankrupted the government. at the time, the central bank of iceland ’ s fx reserves amounted to 2½ billion euros, while the foreign currency deposits in landsbanki ’ s dutch and british branches totalled 11½ billion euros and payment of the eu minimum deposit insurance would have required 4½ billion euros. in economic terms, given that these deposits were used to a significant degree to finance illiquid assets in these same countries, such a payment would have amounted to a net transfer of resources from iceland to these countries at a time when iceland was going through its deepest financial and economic crisis in the post - war period! that made no sense, and the only solution was for the governments concerned to pay out the insurance in their own currency with the aim of settling later with iceland. there are legal arguments about the merit of such claims that i will not comment on here. the fact of the matter is, however, that the icelandic government made three good

problem into a sovereign problem with the serious risk that the sovereign might have defaulted on such foreign currency payments. the decision was, however, never implemented because of the ensuing full - scale run on the foreign liabilities of the banks and the domino effects inside the icelandic economy. but the time to consider the options was rapidly running out. given the lack of international co - operation, the icelandic authorities were forced at this point to consider radical solutions. although they were not necessarily articulated fully at the time, these solutions had several goals : to preserve a functioning domestic payment system, ringfence the state in the case of bank failures, limit the socialisation of private sector losses, and create the conditions for rebuilding a domestic banking system. the adopted solution incorporated several elements. the government declared that all deposits in iceland were safe. second, on 6 october the so - called emergency act was rushed through parliament, giving the financial supervisory authority broad - based powers to intervene in failing institutions, granting all deposits seniority over other unsecured claims in case of bank failures, and giving permission for government capital injections into new domestic banks. the emergency act thus allowed new domestic banks to be created when the old crossborder banks failed and were placed in special resolution regimes followed by winding - up proceedings. in essence, the old banks became the property of the creditors, which were mostly foreign. the new banks were created by carving the domestic assets and liabilities out of the old banks, so it was not a good bank – bad bank split. the idea, then, was that the government would recapitalise the banks and place compensation bonds in the estates of the failed banks. however, valuing the assets and liabilities proved a complicated process in the middle of an economic and financial crisis, and a solution emerged where the creditors of the failed banks became majority owners of two of the banks and kept a small equity stake in the third. this saved the government significant expense in recapitalising the banks. the new banking system amounted to 1. 7 times gdp. as a result, the domestic payment system functioned more or less seamlessly throughout, and customers had continuous access to their deposits. the run on the domestic banks stopped, but at its peak, demand for cash tripled and the central bank almost ran out of banknotes. nonetheless, international payment flows were seriously affected by the freezing order imposed by the uk, and the british authorities ’ suspicion that iceland would not honour deposit insurance in uk branches of