Iceland’s debt comes in from the cold

SAN FRANCISCO (MarketWatch) � Iceland. The mere mention of this rocky island outpost used to send chills down the spine of over-leveraged nations worldwide.

No more. What was once the poster child for economic excess has emerged a role model for countries struggling to save their bacon in the global bond market.

Fitch Ratings on Friday raised its credit rating on Iceland to BBB- from BB+. The move marks the passage of Iceland�s debt from junk back to investment grade. At the same time, Fitch declared Iceland�s economic outlook stable, something that might have seemed unattainable three years ago.

Iceland was the proverbial canary in the mine shaft, a tiny nation (population 313,000) of fishermen and sheepherders that had this crazy notion it could transform itself into a major hub of international finance.

Reuters Smoke rises from the Grimsvotn volcano, under the Vatnajokull glacier in southeast Iceland May 21, 2011. After Iceland's most active volcano erupted, a thick cloud of ash blocked out the daylight at towns and villages at the foot of the glacier where the volcano lies and covered cars and buildings.

It worked, for a while, thanks to easy credit, lax oversight of its banks, clueless credit ratings and a collective abandonment of fundamental economic realities. Sound familiar?

As the money flowed, Icelanders came to believe that maybe, just maybe, they could afford to live like London bankers. Soon they were convinced they could. And while the nation�s sparse gravel roads gave way to paved freeways ferrying a bunch of brand-new Land Rovers, old-timers wondered whether their young financial gurus were leading the nation into the dream realm of the Mountain King.

Then they got their clocks cleaned.

When global credit markets unraveled in 2008, Iceland�s three biggest commercial banks collapsed. Iceland�s debt rating plummeted to junk status. The value of its currency, the krona , fell sharply and a severe economic recession set in.

But it�s a testament to the Icelanders that they quickly recognized they�d built a house of cards and took drastic action to recover that involved, among other things, nationalizing one bank and handing control of all three major banks to the equivalent of a board of creditors.

The tough lessons of the past decade�s excesses galvanized Icelanders. They got to work slashing public spending to bring it closer in line with their GDP, salvaged their tattered currency and, last summer, successfully exited a rescue program set up by the International Monetary Fund. Consequently, Iceland once again has access to international credit markets.

Land Rover sales are no doubt down and Reykjavik�s red-hot night life has probably cooled a bit. But there were never riots in the streets and they never blamed their neighbors for their predicament.

The fact that Icelanders don�t have neighbors might actually be key to their turnaround effort. After spending most of the past 1,000 years isolated from the rest of the world, the need for self-reliance and understanding that actions have consequences are nothing new to them.

That�s probably a timely, and inspiring, lesson for the rest of us.

� Jim Jelter