Hindsight is a glorious thing. Of course. But there were plenty of signs that Icelandic banks were heading towards…pardon the pun….an iceberg.

The entire country had been widely compared to a giant hedge fund, given its penchant for debt. And back in March the cost of protecting Kaupthing and Landsbanki’s bonds (via credit default swaps) rose sharply.

Police authorities and councils say they couldn’t have known what would happen next. When they put deposits in the three Icelandic banks - which were all nationalised this week - the ratings agencies were giving a broadly positive steer.

That is true to some extent. And yes, this is another example of the agencies only noticing problems when it is far too late. There were few explicit warnings about specific Icelandic banks until their fate was already sealed.

But cynics could have spotted one or two implicit comments in agency reports.

In September, Kaupthing was given a reasonable credit rating of Baa1 by Moody’s on the basis that it would be backed by the Icelandic government.

But the same agency gave it a “bank financial strength rating” of just C-; having downgraded it from C on February 2008. That is far from a big thumbs-up.

UPDATE: I’ve just had a message defending councils and blaming flawed government investment advice.

This is what the Tories want you to think.  In fact, the guidance issued under the Local Government Act of 2003 does not sound reckless.

”The general policy objective is that local authorities should invest prudently the surplus funds held on behalf of their communities,” it says. “The guidance recommends that priority should be given to security and liquidity. However, that does not mean that authorities should ignore yield. It will be appropriate to seek the highest rate of return consistent with the proper levels of security and liquidity.”

The most recent advice from the Metropolitan Police Authority advised forces to “maximise the yield from investments”…but only “consistent with the security and liquidity objectives identified.”

October 10, 2008 10:58am in Alistair Darling, Banks | Comment