Its the credit squeeze, stupid.

Talk about negative news flow. Two governments far apart, one in Jefferson County in the State of Alabama the other an island in the North Atlantic, are in big trouble. The common cause, the credit squeeze caused by the collapse of the U.S. subprime mortgage market.

The central bank of Iceland raised its benchmark interest rate unexpectedly to 15.5 percent. This is the second increase in three weeks. The bank raised the benchmark rate an unprecedented 1.25 percentage points at an emergency meeting on March 25. The interest rate hikes are intended to stall a slump in the Icelandic currency the krona, which has fallen 25% against the euro this year, and to curb inflation which was at a six-year high of 8.7 percent last month.

In the current environment investors have lost confidence in the liquidity of Iceland's government. Its three biggest banks, Kaupthing Bank hf, Landsbanki Islands hf and Glitnir, had combined assets 11.4 trillion kroner ($157) billion at the end of last year. Most of it are foreign holdings. Iceland's central bank holds foreign reserves of 213 billion kronur at the end of March. This mismatch is undermining confidence.

``The economy is likely on the verge of a rather sharp turning point,'' the central bank said. ``The recent nose-dive taken by the krona dramatically changes the economic outlook, particularly as regards inflation.''

In Jefferson County, Alabama, its a different story but not really. Financial advisers met yesterday with officials from the U.S. central bank, the Treasury Department and the president's Council of Economic Advisers. They were there to negotiate a bail out, ooh I am sorry, let me rephrase that. They were there to negotiate conditions under which to avoid bankruptcy. If negotiations fail it could be the largest municipal bankruptcy (the Bloomberg report did not say weather in the state or nation).

The problem is the collapse of the auction-rate bond market which has its interest rates on variable rate bonds jump by 10 percent. Ailing municipal bond insurers, who are in their own universe of trouble, did not help the situation either. Without restructuring its bonds, interest costs on its sewer debt may reach $250 million, nearly twice the $138 million the system produces in revenue, according to county Commissioner Bettye Fine Collins. The county has $847 million variable-rate sewer debt from banks. It can't burden residents with higher sewer rates, which have risen more than fourfold since 1997.

Jefferson County Commissioner Jim Carns said about the current situation:
``I certainly don't want bankruptcy. It's obvious that if everything fails that that is a possibility. But I'm certainly not willing to say we're at that point, or anywhere near that point.''


update: Thu. Apr. 10th, 5:00 pm:
Financial Guaranty Insurance Company ("FGIC"), and XL Capital Assurance ("XLCA"), assure Jefferson County to develop solutions to the country's debt crisis. I hope they are in a position to keep their promises.

"If called upon, FGIC and XLCA will stand behind our unconditional, absolute and irrevocable obligation to pay interest and principal, as scheduled, on the insured Jefferson County warrants as provided under the terms of our financial guarantee insurance policies."



source: Iceland Raises Benchmark Interest Rate to 15.5%
Bloomberg,
http://www.bloomberg.com/apps/news?pid=20601085&sid=atYTED7QcGbo&refer=europe

source: Jefferson County Advisers Meet U.S. Officials as Crisis Looms
Bloomberg,
http://www.bloomberg.com/apps/news?pid=20602007&sid=a_.hdWe1xXmM&refer=rates

source: FGIC and XLCA Continue to Work with Jefferson County to Solve Debt Crisis
http://biz.yahoo.com/prnews/080410/mxth006.html?.v=3

read also: Iceland's emergency rate hike
http://manonthestreet64.blogspot.com/2008/03/icelands-emergency-rate-hike.html