From Iceland, a cold blast for investors

British towns sought high returns in banks

A woman left a branch of Iceland's second largest bank, Landsbanki, last month in the capital city, Reykjavik. (Olivier Morin/ AFP/ Getty Images)

SAFFRON WALDEN, England - Since medieval times, this quaint market town has been a wellspring of financial acumen.

Merchants grew rich trading saffron crocuses, the flower that produced deep yellow dyes for the textile industry and gave the town its name. Brewers prospered from the rising demand for beer. In the 19th century, an eminent local family helped establish one of the behemoths of British finance, Barclays Bank.

So some public embarrassment is understandable as officials in Saffron Walden find themselves staring into a black hole where about $3.5 million of taxpayer money used to be.

The sum was invested in an Icelandic bank, in an attempt by the local government, the Uttlesford District Council, to secure a toehold in the high-return world of international financial markets.

But last month, barely a week before the deposit was due to mature with a healthy chunk of interest, the Icelandic government took over the bank as the entire country teetered on the brink of bankruptcy because of the worldwide financial meltdown. Uttlesford abruptly found itself unable to get its cash back.

"It was a move away from our normal practice," John Mitchell, the council's chief executive, said of the offshore venture, adding ruefully: "It all went painfully wrong."

The council's plight is a demonstration of the far-reaching and unforeseen effects of the global financial crisis. Because of the increasing interconnectedness of the world's economy, events in Reykjavik, Iceland's capital, suddenly are being felt in as tucked-away a corner as this pretty patch of eastern England.

Uttlesford is just one of dozens of local authorities in Britain that have parked nearly $1.5 billion in Icelandic bank accounts, which have been promoted aggressively in this country as high-yielding but safe investments.

Well-known charities and nonprofit organizations, including Oxford University and a cancer hospital in northern England, put their funds in Iceland's banks. So did millions of individual Britons, who opened their accounts over the Internet and happily watched their balances grow, at least online. Even the British government's own watchdog agency for public spending confessed to having $16 million tied up in Iceland, whose banking industry was so heavily leveraged that some called the country one giant Viking hedge fund.

When those banks started sinking with stunning swiftness around the beginning of October, officials in Reykjavik were forced to intervene and, essentially, nationalize Iceland's largest financial institutions. Investors in Britain were panic-stricken over money that was frozen by the Icelandic government as it tried to sort out the banking mess. The British government's pledge to back up individual investors' deposits for as much as $80,000 failed to calm nerves, and also did not apply to bodies such as local governments and charities.

Instead, the banking debacle sparked a nasty diplomatic row. Prime Minister Gordon Brown invoked a clause in Britain's antiterrorism law and froze all Icelandic bank assets in this country. For their part, Icelanders bristled at being labeled a nation of extremists.

Despite the faceoff, officials from both sides are working toward a solution for British investors, which is all that Michael Davis, a retired landscape architect, cares about.

"I was in a terrible state. I was actually physically shaking," said Davis, describing his reaction to news that the $125,000 he had deposited in the popular Icesave bank - nearly all his retirement savings - was in danger of being wiped out.

Davis, who lives in a village in the county of Gloucestershire in western England, had been attracted by Icesave's offer of 6.5 percent interest and impressed by repeated endorsements from financial websites, credit-rating agencies and other credible sources that Icelandic banks were sound. He got his fiancee and his daughter to sign up as well.

"I recommended it to my brother, and he's a qualified chartered accountant," said Davis, 62.

Now all Davis has are printouts from the Internet as proof that he ever had money in Icesave, which is owned by Landsbanki, Iceland's second-biggest financial institution.

"You can't go to a branch to get your money back. Where is the money? What happened to it? Who's got it?" he said.

In Saffron Walden, an hour's train journey from London, the Uttlesford District Council also relied on specialists' advice for its decision last year to put $3.5 million in Landsbanki. The council, which provides services such as garbage collection out of a total budget of about $14 million, was counting on more than $200,000 in interest until Reykjavik announced Oct. 7 that it would seize control of the bank.

Almost as appalling as the potential loss of revenue was the loss of face from being one of three local authorities designated by the central government as urgent cases requiring immediate attention.

"There's a sort of stigma associated with that, but there's an opportunity . . . insofar that we're in front of the queue if any money gets dished out," said Mitchell, the council's chief executive. "As a council we've been through a great deal of trouble and we were on our way out when this happened, and it's rather taken the wind out of our sails."

In Worcestershire, the Wyre Forest District Council, another of the three local bodies identified as most at risk, has nearly $14.5 million of public funds socked away in Icelandic banks, or about $145 for every resident. The council's chief executive predicted a "devastating impact" on local services if the situation was not resolved quickly.

"The time that our community most needs us is the time we've got one hand tied behind our back," said John-Paul Campion, the council leader.

London has dispatched a specialist to assist the council in examining its finances and exploring its options, but that, Campion said, is not the issue.

"We don't need someone to come help us manage our budget. We need someone to help us get our money back."