Geir Haarde, Iceland's former prime minister, has been charged with criminal negligence over his part in the collapse of the country's banking sector in 2008, the first credible attempt to hold a head of government accountable for the failures in oversight that led to the global financial crisis.
Pekka Sakki
Punkaharju, FINLAND: Iceland's Prime Minister Geir H. Haarde waves to photographers after steering a timber tractor during the Nordic premiers meeting in Punkaharju, 19 June 2007. The Nordic Prime Ministers meet in Punkaharju to discuss current topics on the United Nations and the European Union. AFP PHOTO LEHTIKUVA / Pekka Sakki *** FINLAND OUT *** (Photo credit should read PEKKA SAKKI/AFP/Getty Images)
The banking crisis and economic downturn has brought down governments - most recently Portugal - and seen others lose at the ballot box. However, none to date has been hauled before a court.
"This is of course a unique thing here for us, and would have been absolutely inconceivable before the crisis," Eirikur Bergmann, director of the Centre for European Studies at Bifrost University in Iceland told CNBC.com.
"Some people see this as part of the recovery process, part of getting out of the mess, trying to properly analyze what happened and trying to hold people accountable. But at the same time, other people feel that this is merely a political vendetta, a political court. There are very mixed feelings in the country on this process," Bergmann said.
"This is really difficult for Iceland. Iceland is a really small society and this is one of the things that is ripping the society apart a bit."
Iceland's economic boom was fuelled by the creation of a large and leveraged financial sector that grew rapidly and became internationally acquisitive. The banks accumulated vast liabilities in foreign currencies and, when the global financial crisis hit, the country's small central bank was unable to act, as other central banks were, as a lender of last resort.
Iceland's banks, while possibly still solvent, were caught in a liquidity crisis that the government could not help them out of. Within two weeks in 2008, Iceland's three biggest banks – Glitnir, Landsbanki and Kaupthing – went into receivership.
That November, the International Monetary Fund and the Nordic countries – Denmark, Finland, Sweden and Norway – prepared a 4.6 billion euro ($6.7 billion) bailout of Iceland.
The collapse of the online bank Icesave, a unit of Landsbanki, caused diplomatic tensions, with the Netherlands and the UK insisting on repayment of the 4 billion euros lost by customers in their respective countries. In two referendums, in 2010 and 2011, Icelandic voters rejected a government plan to pay back the debt.
Without a global reserve currency or the huge liquidity reserves of the Eurozone behind it, the growth of the banking industry in Iceland was reckless, economists Willem Buiter and Anne Sibert wrote in 2008.
"If Iceland was unwilling to take that step (and join the euro), it should not have grown a massive on-shore internationally exposed banking sector," Buiter and Sibert wrote.
"This was clear in July 2008, as it was in April 2008 and in January 2008... We are pretty sure this ought to have been clear in 2006, 2004 or 2000. The Icelandic banks’ business model and Iceland’s global banking ambitions were incompatible with its tiny size and minor-league currency, even if the banks did not have any fundamental insolvency problems."
Iceland is returning to the capital markets this week for the first time since the banking crisis and, whether charging its former prime minister is catharsis or a real desire for accountability, its other attempts at reform are on track, according to the IMF. The Fund released a fresh tranche of its loan last Friday, and said that it expects the country to return to growth later this year.
"Obviously the sooner Iceland can return to markets the better," Julie Kozak, the IMF's mission chief for the country told reporters earlier this week. "It's a very strong signal of a normalization of Iceland's relationship with international capital markets and that's an important signal and it's important for confidence going forward."
Critics say that Iceland's high unemployment rates – currently around 7.5 percent, according to the IMF's 2011 World Economic Outlook – as well as its need to remove capital controls and the ongoing concerns over the Icesave debt, could weigh on its attempts to raise fresh capital.
Barclays Capital, UBS and Citigroup are leading the sale of the anticipated $1 billion issue.
Whether Iceland's image is rehabilitated or not, the precedent set by Haarde's negligence charges could have far-reaching effects, Bergmann told CNBC.com.
"It speaks to the whole financial crisis worldwide. What happened in Iceland isn't greater than what happened in other places. The devastation here is not greater than the devastation felt in Ireland, Portugal, Greece, even parts of the UK. So of course this is in some way a precedent in how countries can deal with a crisis of this magnitude," he said.
"I guess the feeling is that it is the government's job to set up the framework around the financial system, in a way that it can't collapse the whole economy, and if it is proven negligent in that, it should be held accountable."