Is Britain simply a bigger version of Iceland? Certainly the City of London is starting to look a bit too much like Reykjavik, but with taller buildings and fewer cod. It is an exaggeration, but not that much of an exaggeration, to liken the UK to the broken, bankrupt North Atlantic island.

Like Iceland, we boast a huge banking industry out of all proportion to the overall economy. Like Iceland, we have an unfunded depositor lifeboat scheme totally unequipped to grapple with failing banks. Like Iceland, our national output is dwarfed by the vast liabilities of our banks. Like Iceland, our banks for years scoffed at relying on domestic depositors to fund their activities and developed a dangerous addiction to wholesale money. Like Iceland, our Government is poised to go on a borrowing spree to try to soften the pain. Like Iceland, our currency is on the skids as foreign investors pull out.

Our problems are not nearly so extreme, of course, but we’d be foolish to feel terribly smug as the International Monetary Fund and Scandinavian neighbours go in to bathe Iceland’s wounds.

The scale of our problems has still not been understood. In essence the domestic banks are largely bust. The Government’s £500 billion bailout plan is primarily designed not to keep banks lending to small firms and to homebuyers but to prevent an unimaginable financial calamity.

Banks provide the very foundations and plumbing of the entire economy. A failure of confidence in them could still bring the entire capitalist edifice tumbling down.

It suits ministers, however, to maintain the bogus claim that the bailout is about sustaining bank lending. True, that would be a helpful side-effect, but is not the main purpose. Indeed, a gentle and gradual reduction in the indebtedness of individuals and companies is still needed.

At the risk of hyperbole, we should not be worrying about whether this is going to be a thin Christmas for retailers (it is), but whether Britain and the West are about to plunge into a years-long economic Dark Age – complete with mass unemployment and social unrest.

Taxpayers are already facing a loss of almost £10 billion on their investment in Royal Bank of Scotland, Lloyds TSB and HBOS even before the Government hands over a penny. That is what their languishing share prices are saying.

The recession has barely begun and the banks are on their knees. Scores of billions of pounds of bad debts are yet to come, as companies and individuals default on loans.

When in early October officials mapped out the bailout with banks, they insisted that those banks stress-tested their balance sheets for a serious downturn. In the six weeks since then, the outlook has darkened swiftly. The worst-case scenario imaginable then may well be looking like a central-case scenario now.

Richard Pym, executive chairman of Bradford & Bingley, the nationalised bank, told MPs this week that the bank had already stress-tested its mortgage book to see how it would cope with a 25 per cent drop in house prices (answer: £600-800 million of losses). But he no longer regarded this as sufficient and was busy putting much larger house price falls into his equations.

The fattened-up capital cushions of the banks will be enough for a while, but banks remain colossolly levered. It wouldn’t take much of a deterioration in their assets to wipe out all the fresh capital raised. The banks may well have to come back to taxpayers for more. They will be given it, too, albeit at the price of total nationalisation.

One third of Icelanders now want to emigrate, things have got so bad, a recent survey found. The proportion of Britons with similar wanderlust may not be so different before this economic agony passes.

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