REYKJAVIK, Iceland

As recently as last year, Iceland was considered an economic success story. After 16 years of free-market reforms, it was one of the world's 10 richest and freest countries. Efficiently managing its fish stocks -- elsewhere operated with huge losses -- it also enjoyed a strong pension system. Massive tax cuts had led to strong economic growth and rising tax revenues. At the same time, extensive privatization generated about $2 billion for the state, allowing it to pay off most of its debt. The newly privatized...