Media Call: Mallaby and Kahn on Greece and the Eurozone

DAVIDSON:  Hi, this is Adam Davidson.  I write the On Money column at the New York Times Magazine and am cofounder of NPR's Planet Money and very excited to be joined by Robert Kahn, who is a senior fellow for international economics at Council on Foreign Relations.  You can also go to his blog Macro and Markets on the CFR website. 

Sebastian Mallaby has exactly the same title.  He is also senior fellow for international economics at the Council on Foreign Relations, and also blogs frequently.

I am going to, Rob, start with you.  I would love a quick-ish kind of overview of where we are right now.  I have covered the Greece crisis, sometimes intensely, sometimes not at all, over the last five years and it almost — it just feels like Groundhog Day.  We seem to have been in a steady state of Greece is about to leave the euro, they need some desperate negotiation with the Europeans, and it is not clear if it is going to happen or not.

Can you kind of paint the picture, where are we now, how is it different from each one of the last five years?  Can you walk us through that?

KAHN:  Well, I think your Groundhog Day analogy is not a bad one to start with.  You know, since 2010 we have had a series of adjustment programs that have been supported by the IMF, the ECB and the European Commission.  Those programs have all performed pretty poorly, measured both by the reforms that got put in place and also the ability to restart growth.

The 2012 program that provided for a private sector debt restructuring set the targets that we lived with until the beginning of this year, and that program anticipated a return to growth and a 3 percent primary surplus in 2015.  I think over the course of last year it became increasingly clear that program wasn't going to achieve those targets and some significant rethinking was required.

Politics overtook that in January of this year, when the Syriza Party was elected and rejected the orthodoxy embodied in that program and adopted a very contra, you know, approach really in opposition to these policies, and have tried in fits and starts to renegotiate since then.

Facing some significant maturities against a weakening economy and new policies that essentially moved it to primary deficit, what we have seen is a government that has been increasingly scrambling to raise money not just for external debt payments but to meet domestic debt — financial obligations and domestic fiscal obligations.

They have done so through one-off tax holidays, through draining money from state and local accounts and state enterprise accounts.  And also through very significant arrears, and it has been very clear that that process was going to reach the end of the road around now.

So this, the end month payments to the IMF and also pension and wage payments domestically really have become a focal point for the negotiations.  There has been some talk of progress made in terms of headline numbers, in terms of what kind of primary surplus to look for. 

The Europeans have reduced the primary surplus targets they are asking for.  They are now looking for a primary surplus of 1 percent this year and rising more slowly up to something like 3 and a half percent in 2017.

So there is, at least in principle, some significant concession there.  The Greeks would say that they have met those numbers, they have agreed to meet those, but if you actually look at the policies that each side are proposing behind these numbers, there is extraordinarily wide differences in what they are proposing to do.

And the IMF assesses, believes that the policies the Greeks are proposing would produce probably a primary deficit perhaps as much as 1 percent of GDP and may be something smaller.  And so there is a significant gap to be closed, something like 2 percent of GDP in new measures this year if there is to be a deal, and that would involve putting material cuts in pensions, wages and market opening that really crosses fundamental redlines that this government was elected on.

So we have — go ahead, I'm sorry.

DAVIDSON:  No, go ahead.

KAHN:  So I was just going to say, so we have had a series of meetings that really have produced no progress.  We had today a meeting of finance ministers that just concluded.  There apparently was no progress made on that.  We probably will have, if not this weekend, next week have a meeting of leaders with sort of one final grasp. 

But it's hard not to conclude that we are going to go through the end of the month without a deal, which will mean that Greece will miss a payment to the IMF and they will be heading into an environment with some significant controls domestically and really an intensification of the crisis.

DAVIDSON:  Great, and — I mean, not great at that, but great answer.  And I should note for the people on the line, I am just going to ask a couple more questions and then we are going to open it to you.  And David will come on, the operator, in a few minutes and explain how you can get in the queue to ask your question.

Sebastian, I guess the question I am most tempted to ask is basically, is now the time I should dig back in and really care about this, or am I, you know, can I kind of ignore Greece for another five years and dive in in 2020 and see where it is at that point?

Are we reaching an end point?  And what might — what are the various endpoints we might be reaching?

MALLABY:  Well, I think Robert's analysis, you know, brilliantly points to the fact that you need to start focusing on this, Adam, and if you haven't already, you know, shame on you because...

(LAUGHTER)

... this really is, you know, I think the moment of truth approaching.  If they — you know, there's no strong reason, I don't think, to believe that they are going to get their act together and pay the IMF at the end of the month.  And if they don't, we are in for another series of repayment deadlines they are supposed to have been paying, bondholders a couple of times in the first fortnight or so of July.  And then there is a big payment to the European Central Bank on July 20th.

And so I think the next three weeks or so are going to be critical, and what's going to happen, I think, is that if, you know, without getting new external aid from the outside creditors, the Greeks don't have the cash to pay back what they owe.  And at some point along this line one of two things is going to trigger a dramatic break in the story.

One thing that might happen is that the European Central Bank, which has been propping up the Greek banks by providing sort of liquidity to them through the Greek central bank, will start to squeeze that down or even cut it off. 

The Greek — the European Central Bank is supposed to provide a sort of liquidity window, like the discount window that the Fed has in the U.S., provided that it is lending to a sovereign bank against decent collateral.  It is going to be harder and harder to argue that the collateral which the Greek banks provide, which is basically Greek government bonds, is decent quality if Greeks aren't paying back what they owe on those same bonds, right.

So at some point it becomes harder and harder for the European Central Bank to keep on propping up the Greek banks.  And in anticipation of the possibility that the ECB might pull the plug on the Greek banks, you are going to have depositors in Greece being justifiably terrified that their money is in these Greek banks and can't be — and may not be retrievable if the banks go under.

So you are going to see capital flight as people pull euros out of Greek banks and move it outside.  Now it has already happened.  There have been periods of panic in this story in the past where the volume of withdrawals has been quite high.  We have had another sort of spike in the volume just in the last few days.  But if that reaches a critical point, you have a bank run, so that's another way that you could trigger essentially a banking collapse in Greece.

And if you do get the banking collapse then I think you start to see the measures that won't necessarily be — you know, there won't be a headline, you know, we, the government of Greece hereby leave the euro, but it would be measures that amount to creating a separate currency. 

So you could have a freezing of deposits in Greek banks to prevent the bank run, and now all of a sudden a deposit in a Greek bank might be called a euro but it sure isn't the same as having a deposit in a Dutch bank or a German bank, where you can take the euro out and spend it.  So there will be different classes of euro then in the euro system.

Equally to prop up the banks if they are in danger of going under, the Greek government may be forced into printing sort of domestic IOUs in the form of scrip, which again would mean that there would be a de facto extra currency in circulation.

So I think it's sort of a — it's a crab-like crawl sideways over the precipice, not a dramatic single moment, but this is the moment, Adam, to focus on it.

KAHN:  Adam, let me just add one footnote to Sebastian's point on the ECB's dilemma here in terms of providing this extraordinary — this liquidity.  So they have provided an additional 1.1 billion euros this week but they have had deposit outflows apparently well in excess of that already this week.

And in addition to the collateral problem, as Sebastian mentioned, and this sort of deposit outflow, there is also an issue that nonperforming loans appear to be spiking quite dramatically.  I think it's understandable that some borrowers have decided not to pay back, either because their economic conditions are dire or because they simply hope that the bank may not be there in a week or two and they can avoid having to pay.

But for whatever reasons, it is going to be increasingly hard not to make the judgment that these banks are insolvent, and once that judgment is made, the ECB will be forced by its rules to cut off this emergency liquidity.

I think there is actually some forbearance already being in place right now.  I think it is going to be increasingly hard for the ECB to continue to make the kind of positive judgment to keep the money flowing.

DAVIDSON:  So, Rob, when you think through that worst-case scenario, who outside of Greece is going to feel the pain most acutely?  You know, I am certainly curious about those of us here in the U.S., but, you know, peripheral European countries or central European countries?  Is it going to be the financial sector in the U.S. is going to be hit hardest, or trade sensitive sectors?  How do you see that playing out?

KAHN:  Well, a couple of points.  First in terms of Europe, I've argued that while Europe is much better prepared for this than in 2010, 2011, that the markets are underpricing the kind of contagion we will see.  Where will we see it?  Probably not in government bond spreads.  Remember that the ECB right now is part of their quantitative easing program and buying up very significant amounts of European government bonds.

And while spreads have risen, it has not been the kind of spike we have seen in previous crises.  I think the ECB's purchase plan will sort of hide the contagion through those channels.  I think where you will see it is in things they are not buying, which could be equities, bank debt and other sort of higher risk assets in the euro zone.

I think you will see a flight to quality out of Europe, so I think it's probably dollar-positive, which can be good or bad depending on what you think of the current strength of the dollar.

In terms of the U.S., you know, the direct effects are relatively modest in terms of trade obviously, as Greece is quite small.  There is a concern about global growth and its implications for in particular Federal Reserve decision-making at this sort of delicate time.

And so certainly if you believe that a Greek crisis would cause a broader retrenchment in Europe, a declining confidence and a decline in growth prospects, you could tell a story in which the direct trade effects could be significant for the U.S., but otherwise they are relatively modest.  So the worries are probably more in the financial channels.

If a Greek crisis, because of the losses that it forces recognition of around the world, particularly in Europe, leads to some contagion of financial distress, certainly you could see that reflected in the financial conditions in the U.S., offset by the safe haven effect I mentioned earlier.

So certainly you saw in Janet Yellen's comments yesterday a concern, but these kind of effects could well be second order compared to what Europe's facing.

DAVISON:  Got you.  Sebastian, a question I have had throughout this crisis, and it reminds me of the discussion around our own housing crisis, is, are there clear villains here?  You know, is this a story of wildly irresponsible Greek governments that are now being even more irresponsible?  Or is this really a story of predatory German banks taking advantage of naive Greeks back over a decade ago, and now refusing to pay the cost?

And I guess a secondary but related question is, are people — is this actually a rational process?  Is it — are the Greeks being reasonably sophisticated that the best way to get a good deal is to freak everybody out and make them as scared as possible?  So even if they do plan to, quote unquote, do the right thing, that they really want to pretend like they won't to get the best deal possible?  Or are people being kind of nuts, and if so, who is being nuts and how are they being self-destructive?

MALLABY:  Well, the question of, you know, whether this is rational scare tactics, to be followed by a miraculous climb-down and a deal, you know, I'm betting against that.  I think that we are too near to the deadline.  The absolutely last time will be this heads of state meeting that people are now talking about in the next two days or so.  But you know, if there is going to be a breakthrough, that's when it would be.

I haven't, you know — I've talked to people who are relatively close to these negotiations and I just don't hear that from them.  I hear instead a sense of despair and chaos.  The personal relationships between the Greek leader Tsipras and his counterparts elsewhere in Europe, the relationship between Varoufakis, the finance minister, and his counterparts has just turned poisonous and that's never good for getting a rational outcome.

So I don't think this is a sort of rational calculation.  It is true that Varoufakis made his career before as a Keynesian economist, but I think he has misplayed this game quite badly.

There is a view, of course, that, well, maybe he is playing a sensible game because in fact Greece would be better off if it did leave the euro and that, you know, you could wipe the slate clean, renege on all that nasty foreign debt and, you know, devalue your currency so you suddenly get a competitive position for Greece in exports, notably in tourism, and that Greece would be a whole lot better off if it went that route, and you have seen that being argued in plenty of commentary that one sees in Greece.

I think that is sort of fundamentally mistaken, for the reason that the view that leaving could be managed cleanly to produce a better outcome supposes that, you know, Greece has a very functional state.  At if it had a very functional government, we wouldn't be in this position in the first place.

I mean, the fact that they haven't been able to stick with the program, whereas, you know, Greece — I mean, Ireland and Spain and Portugal have done much better in managing their way through austerity and difficulty may tell you something about their starting position, that Greece had worse debts.

But I think it also tells you a lot about the quality of the government and the quality of the ability of the government machinery to collect taxes, to get around corruption and so forth, and that's the problem.

So if you had a departure of Greece from the euro zone, do you really think that they would go through the technical challenge of introducing a whole new national currency cleanly?  And therefore you could evaluate cleanly and get all that competitiveness benefit in their efficiently?  I don't think so for a moment.

I think they would be playing (ph) around, it would be chaotic, and that chaos would be rather long-lived.  Equally, I don't think the Greeks would renege on all that foreign debt suddenly and say, you know, we are not paying anyone in the international community, goodbye.  That would imply losing membership in the International Monetary Fund after a while.  I don't think they would want to go that far.

So I don't think this sort of wipe the slate clean idea, I think is also over.  I think there is a lot of risk here for the Greeks.  There is also some risk for the European partners because even if some of the contagion will be suppressed, as Rob was saying, because the European Central Bank will buy sovereign bonds in Spain and Portugal and so forth, and create the firewall that pretends — that sends a contagion, there could be other kinds of contagion through.

You know, Rob mentioned equities, but I would mention political contagion.  You know, you don't want Europe to have to deal with a Greece is a member of NATO but all of a sudden hates the West and is cozying up to Russia.  So that is the different kind of cost from a Greek exit.

So I think in other words both sides have a lot to lose.  It is not rational for them to want to leave.  I think it has gone beyond the point where they are simply bluffing and they are going to turn around and do a deal, so I'm rather pessimistic about the next three weeks or so.

DAVIDSON:  OK.  Well, on that depressing note let's open it up to callers.  David, do you want to explain how they can get in the queue?

OPERATOR:  Yes, sir.  Ladies and gentlemen, at this time the floor is open for your questions.  If you would like to ask a question, you may do so now by pressing *1 on your touchtone phone.  We will be taking questions in the order they are received.  If at any time you need to remove yourself from the questioning queue, or your question has been answered, press *2.  Again, to ask a question, please press *1 now.

Give it just a moment for people to queue up.

And our first question comes from Charles Lane with the Washington Post.

QUESTION:  Hi, thanks for a good presentation by both of you.  I wanted to ask a question that it may seem a little small bore but it struck me that — I always mispronounce his name — Mr. Tsipras had an editorial in the German press today protesting that actually the Greek pensions are not so out of line.

And his basic point was the reason they loom as such a large percentage of our GDP is not that they are so overly generous but that they are — the GDP has collapsed, and that it's therefore, you know — and it's not even the elderly who are living off these pensions anymore, but the children of the elderly because they have no jobs.

I must say, I thought those — I thought his defense of the Greek pension programs, which I had been inclined to regard as sort of terribly managed and extravagant, was surprisingly credible.  I wonder if you guys have any thoughts on that point, because this is obviously a huge sticking point in the talks.

MALLABY:   I'll just make a small point and then maybe Rob has a more substantive and impressive one.  And my small point is to say that if Tsipras is reduced to defending the pension payments by saying that this is an important way for the unemployed kids of the retirees to be supported, I mean, that's a pretty strange conception of what a pension program is supposed to do.

You can make a separate argument that at a time a very high youth unemployment that youth unemployed need to be supported.  But obviously a pension payment locks you into paying that retiree, you know, forever until they die, and then hopefully the depression in Greece won't last that long.

So I heard the same argument not just from Tsipras in his op-ed, but also there was a very revealing interview on BBC this morning with the chief Greek negotiator, who is forwardly (ph) articulate and persuasive guy, you know, went to high school in Britain and, you know, uses that to persuade the British radio listening public to great effect with his arguments.

He made exactly the same point, but I didn't think it was one of his best ones.

KAHN:   Yes.  So Charles, I would sort of throw out two numbers to start off with.  So pensions expenditures are 16 percent of GDP.  You are right to say GDP has been crushed by the recession, but that still is an extraordinarily high number.  That requires 10 percent of GDP each year government transfer to the pension system to close the gap.

And what that means is that if you take the pensions and the wages together, you are talking about three-quarters of primary spending.  It is squeezing out everything else.  And that is the core of the problem.

I mean, you are right to say — it's part of the social safety net which is not targeted, it's very broad and has strong disincentives to work.  And so I think one of the things that the commission has been — sort of felt they had been a little misrepresented on in this debate is they are not arguing for cutting the amount of the full retirement pension. 

They feel you can take this thing from 16 percent of GDP to 15 percent by essentially, you know, putting in reasonable retirement ages and eliminating some of the opt-outs for very early retirement, and otherwise kind of reforming the system in ways that could probably save a decent bit of money.

And the problem is, unless you are going to find someone to finance large and continuing deficits, you can't allow this much of your spending to go to these two items, and I think that is the inconsistency in the argument they are making.

QUESTION:  Thanks.

OPERATOR:  Our next question comes from Dale Ponikivar (ph) with the Millbank (ph).

QUESTION:  Hi.  I am a retired Millbank (ph) partner that was involved in representing the creditors committees in Lehman, Enron, and representing the debtor and long-term capital management.

What strikes me about the discussion is, and the press coverage is that it's Greece versus Germany and other nation-states.  The FT points out this morning that 18 percent of the Greek debt, without defining Greek debt, is held by private parties, not by governments.

I'm kind of curious just to know the details here a little more because that's usually where the devil and the solutions lie.  It's kind of like who owes what to whom.  In other words, there are the Greek banks, and there's the Greek government.  There's the German government and the German banks, although my understanding of the German situation at least is that the German government had bought out, or if you will, bailed out the German banks of their Greek debts by and large.

Who owes what to home?  You know, the concept that there is one trigger date would make sense if there were just  one borrower because there would be all kinds of cross defaults.  But if you've got multiple borrowers with different loans, I would imagine that the D-Day for the different lenders is different.  Can you comment on that?

KAHN:  Yes.  I mean, after the 2012 private debt restructuring it's been the case that the vast majority of the external debt is official and mainly European claims and IMF claims on Greece, and that's why the focus of these negotiations has been on that.

Those payments, except for the IMF payments, the European payments have already seen low interest rates apply to them and an extension of maturity.  So the actual, you know, payments due on that debt are relatively modest relative to the size of the debt.  Still, if you look at debt outstanding, that is the largest piece of it, and so is been the focal point of renegotiations on debt relief.

In terms of the deadlines and when things, it isn't as clean as maybe it is sometimes portrayed.  There has been a lot of focus on this IMF payment that is due on the 30th.  It was actually due earlier in the month but the Fund has allowed the Greeks to basically bundle the payments due this month and pay them at the end.

If they miss the payment to the IMF, that in principle could trigger cross-defaults to other official claims, including the ESM, but that's, I believe, at the discretion of those lenders.  So you could be — the day after they miss their IMF payment, the world does not have to come to an end. 

It really will be a political judgment by the creditors whether they use that as a trigger to say we cannot continue the current financing arrangements.  And what Sebastian said earlier about the particular bind that puts the ECB in because of all the collateral they hold is particularly important there.

But it could drift for a while.  Indeed, if Greece was running a primary surplus — in other words, if they had a surplus net of interest payments, they could in a sense stop paying on their external debt and still meet essential domestic payments.  I believe that's not the case.  I believe they have now a significant primary deficit if you include all the arrears they are generating.

So even if there was forbearance by official creditors, and they didn't in a sense, you know, accelerate everything and call a default, you would still probably have huge pressure — you would still have huge pressures on the government because of the difficulty making domestic payments.  And then the arrears that are generating would I think cause — is already causing a cascading problem in the economy.

And so the scenario in which we are looking at bank controls and capital controls and rising arrears is one which probably can't go on very long, even if there is forbearance on the external debt.  But it is a kind of floating deadline and it's hard to say that it's all over on a certain day.

QUESTION:  Can I ask you to focus a little bit on the difference between who the borrowers are?  Because I take it there are both the Greek government and the Greek banks, because we are talking about the Greek banks being declared insolvent.  Would that be...

KAHN:  Well, a large part of the Greek bank balance sheet are government bonds.  They are in essence on the margin.  They are being financed by this ELA assistance from the European system of national central banks.

And so if that — if they can't roll that — that's in a sense an immediate cause of insolvency.  In that sense I think people do presume that the government stands behind those banks to the extent it can.  I don't know if that answers your question.

QUESTION:  It's a step there.  It just strikes me that the process of simplification of what they, you know — it's largely presented Greece versus Europe/Germany, and then that changes the whole tone of the discussion about, yes, should hard-working Germans be supporting lazy Greeks, and that's certainly the discussion going on in Germany today.

KAHN:  Well, supporting has two elements, right.  There's a question of debt relief.  And I think there is a broad sense, a broad perception that there will need to ultimately be — some significant debt relief from the official sector to make, to put Greece on a sustainable path within the euro zone.

But then there's the question of what kind of ongoing financing should the Europeans reasonably be asked to provide, and I think that is — that is in some sense the heart of the argument for the Greeks to make right now, that they should be — because I would argue that the policies that they are prepared to run would generate medium-term deficits that would require additional financing, right.

And the resistance of Europe to do that is why I think there is such strong insistence on the set of reforms in pensions and wages and social safety net.

QUESTION:  Thank you.

OPERATOR:  Again, if you would like to ask a question, please press *1 at any time.  Our next question comes from Michael Mostettig (ph) with PBS Online Newshour.

QUESTION:  Yes, Mike Mostettig (ph) here.  Sebastian sort of touched on this, but to what extent can you, particularly when the political leaders get together, whenever they get together, sort out the political issue of the damage to Europe if Greece collapses versus all these technical issues that the financial people are dealing with?

Sebastian I think has implied, if I understand correctly, that the problems are so immense now and the deadline is so close that even if the political leaders, particularly Merkel, wanted to take this out of the hands of the financial people and come up with a big deal, that they can't.

But again, the basic point is, how do you sort out the political issue of a Greek collapse from all the economic issues or financial issues?

MALLABY:   Mike, I think what you are saying is, you know, this is the one ray of hope in the whole picture, is that if you think about it, you know, from a financial perspective only, and you're sitting in Germany and you are the finance minister, you would probably end up with the same view that the real finance minister has.

In other words, Wolfgang Schaeuble's view is that Greece should have left a long time ago, that, you know, there's no use throwing good money after bad to these guys.  And since the European Central Bank has succeeded in controlling the level of sovereign interest rates in the other troubled economies in Europe, there is kind of a firewall and you can afford to let the Greeks go, and the Spanish and Portuguese and so forth would be OK.  So that's the view.

The chances of kind of holding this thing together lie more from Merkel, who has a broader perspective.  She has done a lot directly and in person with Vladimir Putin.  She doesn't love the idea that, you know, Putin would be presented with a gift if the Greeks were thoroughly, even more than they already are, alienated from their West European partners and would sort of fall into the arms of Russia. 

Tsipras made this high profile trip to Moscow in April and, you know, denounced European sanctions on Russia when he was there.  So you can easily see how geopolitically this would be a gift of the Russians.

Merkel doesn't want that and so maybe she would try to overrule Schaeuble, the finance minister, and push Europe into a more conciliatory position toward Greece.  The problem is that, you know, she would probably face a revolt in her own party.  She already didn't get all of her CDU, CSU conservative coalition last time around when they voted on aid for Greece.  She would get less of it now.

Schaeuble is known publicly to be, you know, not on her side on this.  The Bundestag is not on her side on this.  The media in Germany are highly critical of Greece, and so, you know, the Bildseissen (ph), the tabloid media voice there, is, you know, highly, highly aggressive on pushing Greece out, you know.

So basically, you know, Merkel would be going up against the tide of opinion in her own country and it would be — it's not clear that she is going to — her foreign policy side may wish to avoid giving Putin this gift.  At the same time, her domestic political antennae would tell her that she is making a mistake if she takes Greece's side in this.

OPERATOR:  Our next question comes from Charles Lane with the Washington Post.

QUESTION:  Thank you.  I wanted to just ask something of a follow up on that, which — well, more like a follow-up on the previous question to that, which has to do with the distribution of this debt among official and private sector creditors.

Is it necessarily the case that because the debt is concentrated now in the hands of official creditors, including the ECB, that there has to be any kind of a — they have to mark this to market, they have to take a hit to the ECB capital?  Does any of that have to happen in the short run?  And if so, how does that affect, you know, how it plays out?  I hope that's clear.

KAHN:  Sebastian may know the institutional parts better than I do.  My understanding is for the most part they are not mark to market requirements on the official credit, and so there is an element of forbearance that can come into play in an environment where at least where a deal was perhaps expected and maybe the politics aren't — were not as toxic as they are currently.

The one possible exception, the one exception to that is the point that Sebastian mentioned earlier, that so when the ECB extends credit under the ELA, the emergency lending facility, they collect collateral from the Greek banks.  That collateral primarily are government bonds, and they collect essentially 100 for every 80 cents they give under the current rules.

And while they don't explicitly mark that to market, there's clearly a lot of attention paid to that.  I think there is a political mark to market on that.  And if you have broad nonpayment by Greece including on their government debt broadly, you know, it's going to be very hard for the ECB not to acknowledge that that collateral fell short of the value of what they have out to Greece, into Greek banks.  I think that's a forcing event and that's why I think that can't go on very long.

Is that a direct mark to market in a literal financial sense?  No, but I think practically it's pretty close.

QUESTION:  Well, and just in the same vein, you know, Sebastian alluded to Schaeuble's view that they sort of — I hope I'm paraphrasing you correctly, Sebastian — they have sort of sorted out the other basket cases to the point where they are fairly confident that they won't — there won't be that kind of contagion.

Notwithstanding what the geopolitics of that might be, is he right about that?  In other words, that, you know, Italian bonds will continue to be OK, and Spanish bonds and so forth, and that this really is now just confined to Greece?

MALLABY:  I think he is right.  I think, you know, that you've got a position where the Greeks are — where the European Central Bank has already been in crisis-fighting mode for a while and therefore, it's not like Lehman where, you know, people weren't — you know, the Fed was not already in the mode of emergency liquidity in all directions, and so there was a bit of, you know, there was a week or 10 days of complete meltdown and mayhem after Lehman.

If you imagine a case where, you know, the Fed had already been in the mode of handing out large amounts of liquidity to everyone in sight before Lehman then, you know, the Lehman shot would have been much smaller.  So, you know, it's always tough before these events to be sure about this, and there could be something, like Rob said, where the risk shows up in someplace you didn't expect it.  You know, equities is a kind of very plain-vanilla one but there might be some fancier, you know...

KAHN: External (ph) markets, for example.

MALLABY:   ... right, where you'd see it.  So it's, you know, never say never.  But I think that in the big game of kind of government borrowing costs, I would — that Schaeuble is right.

QUESTION:  Well, if I may follow up just one more thing on the geopolitics.  You gave an answer respecting Russia, which is sort of like the eastward side of that.  Think about the westward side for a moment. 

So is one interpretation of the German stance here that they see sort of a specter haunting Europe of populist parties generally, and that — Syriza is the first one to actually gain power in any country, and that part of what their agenda is here is just showing that that can't get you anywhere, that electing that kind of government won't lead you to any kind of concession, or indeed any kind of success.

MALLABY:  Yes, that could be right.  I mean, you know, I think the Germans have, you know, a couple of reasons to be — to take a hard line on this.  The first is domestic political opinion and not wanting to throw money at the Greeks, who are viewed as undeserving.  And the second is not wanting to encourage other Syriza-like parties like Podemos in Spain, because obviously if you cut the Greeks a sweet deal then the Spanish will be lining up wanting the same thing.

QUESTION:  Right.  Thank you.

OPERATOR:  At this time we have no other questioners in the queue.

DAVIDSON:  This is Adam.  I will just ask sort of a summing up question, and then I think we will let everyone go.

So if this is something like the end of the chapter on this, I mean, if in the next few months where, you know, Greece finds a resolution, maybe not a great one but it is resolved, can you just think about what this says, you know, for the years and decades to come.

We talked about Lehman, we talked a little bit about our own financial crisis here in the U.S. and we are still figuring that out.  But does this mean the euro as a project is over?  Does this mean, you know, massive currency unions are over?  Does it strengthen them because now we have a better sense of what the edges are and how to structure these things better?

Is there a moral hazard issue here that will be improved if we actually finally in this financial crisis see real pain to people who actually lent money to insolvent institutions?  Can you just think about what the long-term implications are?

KAHN:  I'll go first.  I'm skeptical of these arguments that Greece's exit is the end of the European project or of the euro generally.  I think you could well see, particularly given it's likely to be a very painful exit, for reasons Sebastian noted.

You know, I don't think other countries are going to look at that and see that as a desirable path.  I think it could well, you know, address some of these moral hazard concerns, strengthen the commitment and consistency of policies across other countries. 

I think it will probably have a freezing effect on other countries joining the euro.  I mean, if you are sitting there in Poland, you don't want to have anything of the euro, that will even be more so after this.

But I see no reason why this couldn't work out in a way that ultimately strengthened the euro zone for the rest of the countries.  I still think there are some fundamental issues that have to be addressed, and particularly fiscal union, if you're going to have a resilient and sustainable monetary union, but we might be making a step closer to that, not further away from it, with these events.

MALLABY:  Yes, I agree with what Rob said.  There is a view out there that says this would be terrible if Greece left the European project because, you know, you would show that somebody can leave, and so instead of it being an irrevocable currency union, it would be a sort of, you know, as long as it works kind of union.  And therefore, the moment somebody got into trouble, the markets would bet more aggressively that they are going to leave and you would see, you know, a sort of devastating run on the country, which would make the whole thing very brittle.  So that's the view that says, you know, this is disastrous.

But I tend on balance to the other view, which is basically says, look, what happened after the Asian crisis in '97, '98?  What happened was that, having gone through that, emerging markets took the lesson that you had better accumulate reserves and you had better, you know, protect yourself from the next time.  You don't want the IMF coming to you with 733 conditions, including sort of, you know, breaking your clothes market or something.  I mean, the detailed prescriptions that were imposed on Indonesia and, you know, the government wound up falling.

So other emerging market governments, you know, saved a lot, accumulated massive central bank reserves and generally adopted somewhat better macro policies to avoid the same vulnerability.  And I think you would have a similar, you know, trend towards prudence in the euro zone if Greece painfully exited.

DAVIDSON:  I did have one last question.  Sorry.  Could you just talk about what life is going to be like for Greeks?  Not the government but the average Greek.  They have lost something like 30 percent of their per capita income, they are about a third poor than they were five, six years ago.  What do you imagine the next decade holds, next 20 years for them?

KAHN:  I think if they do end up in the scenario we are talking a lot about, in which it would just — banking controls, a disorderly adjustment process that might ultimately lead to an exit, I think there's going to be an extraordinarily large further adjustment in living standards that's going to have to take place.

Greece doesn't really have a strong and well diversified tradable goods sector.  I think exchange rate, the real exchange rate has to fall a very long way to make Greece competitive.  Often people compare this to the example of Argentina, where you had a significant exchange rate fall but you also then had — in 2001, 2002, but then you also had a pretty material rebound in activity and trade.

I think it would be much harder to get that, and so I think the exchange rate — you know, the new exchange rate would have to be much depreciated relative to where we are now.

MALLABY:  The other thing about Argentina is that Argentina, you know, had a peso that was linked to the dollar, but there were pesos in circulation and so contracts between companies were often written in pesos.  When the dollar link snapped, there was a sort of functioning set of contracts, a functioning currency that the country could fall back on.

Greece doesn't have that.  Doesn't have a drachma.  Every contract is written in euros, and if it leaves the euro then they are going to be fighting about which currency do you repay in.  I think the chaos factor would be much, much bigger than it was in Argentina.  I think the first result would be that any Greek who is mobile will leave because the economy will be in a literal mess.

The most sort of, you know, talented, ambitious and educated, even more than is the case already, will leave the country and that will be extremely bad for long-run growth prospects.  I think, you know — a really sustained negative spiral couldn't be ruled out.

DAVIDSON:  All right.  I'd love to end on a positive note but I guess the truth won't let us do that.  Thank you both.  I found this a truly fascinating and very helpful conversation.

Thank you.  I know all the other folks on the call are sending their thanks as well.  Thank you, guys, and thanks everyone who tuned in.

MALLABY:   Thanks, Adam.

KAHN:  Thanks for having us, yes.