The best way of seeing Iceland is as a country that turned itself into a giant hedge fund.
For years it paid higher interest rates than in many parts of the world, so its financial institutions borrowed a ton of hot money from abroad, which they then re-cycled into investments all over northern Europe, including the UK.
The Icelandic banking boom was an economic phenomenon created by what’s known as the carry trade - whereby colossal sums of money were borrowed in places like Japan, where interest rates were effectively zero, for lending to institutions in high-interest-paying economies, such as Iceland.
This, for years, seemed to be a no-lose arbitrage on differential interest rates in a globalised economy.
But it was just another manifestation of the pumping up of the credit bubble, which is now deflating
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10/creditors_call_time_on_iceland.html