Banker Isabella Kvaran pulls the fur hood of her blue goose-down parka over her head on a pitch-dark December morning. She walks down Reykjavik’s Skolavordustigur street to the Bernhoft bakery for her morning vínarbrauð – a Danish with chocolate. Today, instead of continuing the two blocks to the Landsbanki headquarters where she worked in investor relations for two years, she heads back to her apartment where she will spend the day scanning French websites such as pacajob.com and emploi-monaco.com looking for work. In October, Landsbanki shut down the international banking department and Kvaran, along with 40 colleagues in her department, were let go. “If I had another job, I’d move now.” Twenty-seven- year-old Kvaran has a masters degree in international relations and diplomacy from Schiller International University in London, a BA in psychology from the Sorbonne and she speaks six languages. “Landsbanki was an institution. It was founded in 1886 before my grandparents were born. I was going to stay there for life.” Now the mortgage loan on her two-bedroom apartment has increased by 3.5m krona (€22,350) and her severance pay ends on 31 January. “Whatever comes along, I’m up for it,” says Kvaran.

Johann Meunier shut the doors on his downtown clothing shop on 6 October. “Fashion in Reykjavik was stuck in the 1980s for a long time. I was selling the current season of Paris ready-to-wear.” Meunier saw the first signs of the economic collapse as early as January 2008. “Our currency dropped so fast and I was buying in euros. I was in deep trouble late summer and when a man’s suit began to cost the equivalent of a month’s salary, I knew I had to shut down.” Meunier has found a job in Mumbai working for an Indian luxury goods company.

Karl Sigurdarson, 29, wears a thin black leather jacket but insists he is not cold as he walks to Kaffibarinn bar in downtown Reykjavik on a biting cold winter night. He worked for the past eight years at the B&L Land Rover and BMW dealership, personally selling 20 cars a month. “We started to feel it long before the banks collapsed,” says Sigurdarson who was fired along with 20 colleagues on 1 September. “In 2007, 16,000 new cars were sold in Iceland,” he says, but by the end of last summer only 5,000 to 6,000 had been shifted. He plans to move to Dubai in the next few months.

Only three months ago, Iceland was riding an all-time high. The handball team had won the silver medal at the Beijing Olympic Games. A famous Reykjavik bar, Sirkus, was reconstructed at London’s Frieze Art Fair in October, and livened up the otherwise depressed art scene. Icelandic banks, along with local businesses such as Actavis pharmaceuticals and Marel food processing equipment, were experiencing huge international growth. Iceland was being lauded as a leader in the field of geothermal energy and recent innovations in marine technology had made fishing one of its leading exports again. And tourism had tripled from 2007 to 2008. The government was so popular that last summer, the president Olafur Ragnar Grimsson was re-elected for his fourth term. Then the banks collapsed.

For the 300,000 Icelanders, the 8 October failure of the banking system rocked the island to its core. Thorbjorn Broddason, professor of sociology at University of Iceland says, “Monday 6 October was our September 11. Nobody died but I won’t forget the white letters on a black TV screen announcing that the prime minister is going to address the nation at 4pm. The address was meant to calm us but it was a total shock to people. Icelanders are bewildered, desperate and uncertain about what’s going to happen.”

Now, Icelanders have lost confidence in their government and spend most Saturdays protesting in the central square in front of the Althingi (parliament). The citizens are demanding accountability, new elections and the resignation of David Oddsson (also see page 16), the former prime minister and head of the central bank, and Icelandic billionaire Jon Johannesson, a shareholder in Glitnir bank and owner of supermarket Bonus.

“Clearly we’ve come through a big shock over the past eight to nine weeks since 6 October when I gave my TV ­address,” says Prime Minister Geir Haarde. “There was a lot of emotion – surprise, anger, denial and a mixture of all of the above. But now I think people are looking forward and moving into fighting mode. If you look at our history, we’ve been through many economic and natural catastrophes. We are hardworking people. We are originally a nation of farmers and fisherman, seasonal workers. People take things in cycles here and we are getting ready to battle through. I think it will take one and a half to two years to turn the tide.”

But how far down the road to disaster are they really? It’s hard to tell on Laugavegur, Reykjavik’s main drag, which is still lively. Tourists flock to the shops here due to the weak krona. Icelanders cram the Skifan bookstore and Kaffitar café. Only B5, the banker’s favourite bar where they downed $1,000 bottles of champagne just months ago, is empty.

But the question remains: will young Icelanders, who are highly skilled and globally minded, pick up and leave?

Haarde admits, “The younger generation moving is definitely a concern and it’s a big challenge for all of us to make sure this doesn’t happen. We’re a small island community and it’s always a temptation for younger educated people to move to greener pastures. But it’s particularly challenging now, with the impact of the bank collapse and macroeconomic consequences of that. We are facing serious economic difficulties and need to move quickly to get ourselves through the crisis and create new opportunities.”

The fact that the slump is global is one good reason for Icelanders to stay put. Another is that many are prisoners of their mortgages. Most Icelanders have taken out house loans in foreign currencies and have to pay them off with a devalued krona. On top of that, mortgages are indexed against inflation – which hit 17 per cent in November and is projected to hit 22.9 per cent in early 2009.

Hairdresser Tota Johannesdottir is leaving anyway. “Things here are so hopeless, I just want to leave. I’m going to Sweden. I can work there.” Johannesdottir put her flat on the market and both she and her real estate agent were shocked that two buyers were interested.

Construction worker Bjorn Stefansson has decided to move to Norway in January and get a job sailing tourist boats. “It’s anarchy here, otherwise I wouldn’t think of leaving,” he says. But I’m bankrupt. The value of my flat is down. My salary is down, there’s not much left. I make 160,000 krona a month and my mortgage payment is 170,000 krona.”

Others feel that it’s their patriotic duty to come back and help. Icelandic filmmaker Thoranna Sigurdardottir lives in LA but says, “Among my Icelandic friends here in the US, there is a feeling that everyone wants to go home now to help out. We are one big family there. I bet a lot of creative stuff is going to come out of this.”

Her sister Svanhildur Sigurdardottir and husband Baldur Már moved back from New York three weeks before the collapse. Már lost his job with Glitnir Bank but was rehired by the “new” Glitnir at a lower salary. They plan to stay. Svanhildur says, “I feel obligated to be here and want to help. I’m starting my own company to create children’s products with Icelandic wool.”

There are other examples of Icelandic resolve. Helga Snjolfsdottir, an ­engineer at Ossur, will stay in Iceland. “When talented people lose their jobs, they will make opportunities for themselves,” he says. Markus Mani Michaelsson Maute’s capital markets job at Staumer has not been affected. “We are tough people,” he says. “This is a time of incredible opportunity. We are the first to go down. We’ll be the first to get back up.”

Playwright Thorleifer Arnasson came back from Berlin because of the recession. “My sister’s in trouble,” he says. He is lending her his overdraft in euros until spring (the interest rate on his overdraft is 12.6 per cent versus 27 per cent on an overdraft in Iceland). “A lot of rebuilding needs to be done. Arts are vital to that.”

Certainly, creative people are stepping forward with solutions. Singer Björk, who is quickly becoming Iceland’s Bono, has started a website called nattura.info to gather ideas for innovative and ecologically minded solutions for Iceland’s future. Others are fighting back too. IcelandAir is going all out to pull in foreign tourists and has cut costs by laying off 350 employees and leasing its idle aircraft to airlines in Russia and Venezuela. And Orri Vigfusson, of the North Atlantic Salmon Fund, says, “I have the solution for fishing in Iceland. We need to rebrand Iceland fish with an eco label and make it the most desirable fish in world.”

Geologically and economically, Iceland is an earthquake zone. The country survived the collapse of the herring industry in the 1960s, the Heimaey volcano eruption in 1973 and the krona’s collapse in the early 1990s.

Prime Minister Haarde says, “This is not something I would have wished to deal with but it happened on my watch and I’m not quitting. I’m going to lead the country through this situation. I’m working hard and so is everybody. We are in a crisis that we are managing the best we can. We will be making a recovery and we will be back on our feet soon.”

The Icelandic spirit could be the thing that pulls them out of this. The country has always taken care of them, now they want to honour the debt.