November 30, 2025November 30, 2025

Iceland’s Meltdown: How the Yen Carry Trade Broke a Nation

In 2008, Iceland suffered a catastrophic financial collapse: its three largest banks failed in a single week, with their assets ballooning to over 10× the country’s GDP. With a population of just 320,000, Iceland experienced history’s largest banking collapse relative to its economy. By the crisis’s end, the Icelandic Króna went into
free-fall, losing more than 50%.

Central to the meltdown was the yen carry trade.

A Hedge Fund Disguised as a Country?

Michael Lewis famously remarked in The Big Short, “Iceland is no longer a country. It is a hedge fund.”

1. From Fishing to Finance: The Making of a Bubble:

Iceland privatized its state banks around 2002. With such a small population, the banks had minimal domestic deposits, so they financed growth by tapping easy credit abroad. Interest rates in Iceland were kept extremely high (e.g., 15.5% in April 2008) as the central bank tried to curb inflation. But those high rates had an unintended effect: they attracted a flood of foreign money via the carry trade.

2. The Yen Carry Trade: Cheap Yen, Expensive Lessons:

Icelandic households and companies also loaded up on foreign-currency debt to finance homes, cars, and investments with cheap yen. Iceland’s banks—Kaupthing, Landsbanki, and Glitnir—became heavily dependent on this mechanism.

In nominal terms, the three banks grew from just a few billion euros of assets to over €100 billion (about 14.4 trillion ISK) by mid-2008.

By 2008, over half of all new corporate loans were denominated in foreign currencies, and a large share of household debt was linked to exchange rates. As long as the Króna stayed strong, this strategy seemed to work.

3. The Unwinding: When the Party Stopped, Everyone Ran for the Exits

In 2008, the global financial crisis hit, and the carry trade completely collapsed.

When the Króna dropped against the yen, debts ballooned in local-currency terms. At one point, it traded at
ISK 340 per euro (compared to 90–130 ISK/EUR in previous years), losing more than half its value before trading was shut down.

The yen surged from ~¥125/$ to ~¥87/$ as global investors unwound positions.

Trust Evaporates

By October 2008, the crisis peaked.

Iceland’s major banks—Kaupthing, Landsbanki, and Glitnir—defaulted within one week. The stock market, already
sharply down, collapsed further (OMX Iceland 15 lost over 90% of its value in euro terms).

The government froze all trading on the exchange for two days, to prevent further panic from spreading through the country’s financial markets.

Iceland’s crisis was caused not only by the yen carry trade—there were many other sins: excessive leverage, weak regulation, a massive property bubble, and reckless expansion abroad. But the foreign-currency mismatch was a key accelerant.

The Immediate Aftermath

The IMF was called in. The IMF and friendly nations lent Iceland $5 billion (1,190% of Iceland’s IMF quota) to bolster foreign exchange reserves and fund government deficits.

The IMF program (2008–11) helped restore confidence providing a platform for reforms. By 2011, Iceland met program targets & was growing again.

Conclusion: No Imminent Collapse, but a Critical Risk to Monitor

Iceland’s 2008 crisis is a dramatic cautionary tale of how a tiny economy became over-leveraged through foreign borrowing and carry trades—and how quickly it all unraveled when the tide turned.