As German Finance Minister Wolfgang Schaeuble dares Greece toquit the euro, investors and economists are mapping out what he andfellow policy makers need to do to save the single currency iftheir bluff is called.

Emergency lending and bond buying from the European Central Bankcoupled with recapitalizations and deposit insurance for lendersand broader powers for the region's rescue fund are among theprescriptions for insulating Spain and other cash-strained nationsfrom what Citigroup Inc. calls a “Grexit.”

Pressure for contingency plans are mounting as Greece'selectoral quagmire forces euro-area officials to publicly revivethe once forbidden topic of whether a nation can leave the singlecurrency. Schaeuble told today's Rheinische Post newspaper that theeuro area could handle a Greek departure as “the risks of contagionfor other countries of the euro zone have been reduced.”

“Any exit would need to be done as part of a package to reducedisruptions,” said Mohamed El-Erian, chief executive officer atNewport Beach, California-based Pacific Investment Management Co.,which manages the world's largest bond fund. “At this stage, it'svery easy to find things wrong with any approach that isproposed.”

The risk is if Greece leaves and the save-the-euro responseflops the world economy could face a sovereign-version of LehmanBrothers Holdings Inc.'s collapse. That makes Schaeuble'sconfidence sound all too similar to former U.S. Treasury SecretaryHenry M. Paulson's optimism that the U.S. financial system couldwithstand the 2008 loss of Lehman Brothers, only to witness thedeepest global recession since World War II and a 40 percent slidein the Standard & Poor's 500 Index in six months.

“If there's no contagion who cares about Greece, but I wouldn'tbe so sure and if I were Germany I'd not be willing to risk iteither,” Jim O'Neill, chairman of Goldman Sachs Asset Management,said in a May 9 interview. “If a Greek exit had unforeseenconsequences for contagion across countries it would have been ahuge mistake.”

Decades in the making and 13 years in existence, the euro- areain its present 17-nation form is in jeopardy after Greece's votersbacked parties allergic to the terms of its bailouts, depriving itof a working government and risking access to the aid it needs topay its bills and meet debt maturities.

Survey Results

A post-election poll of 1,253 Bloomberg subscribers last weekfound 57 percent expect at least one country to leave the currencythis year, the most since the survey began in 2010 and up from 11percent in January 2011.

A splintering of the euro region would leave authorities rushingto avoid capital flight, a default-inducing surge in bond yieldsand bank runs in the remaining fiscally-stretched nations. WhileGreece accounts for just about 2 percent of the region's grossdomestic product, its leaving would set a precedent in a currencyarea that was supposed to have no way out and could promptinvestors to raise the threat of default and departureelsewhere.

“A sudden exit of a country from the euro could well lead tofinancial panic and market selloffs, as well as spikes involatility and interbank borrowing rates,” said Alan Brown, senioradviser to Schroders Plc in London, which oversees the equivalentof about $323 billion.

Containing those threats would be vital because the cost of abroader break-up would be “very large” given the region'sfinancial, trade and strategic links, said Willem Buiter, theLondon-based chief economist at Citigroup, who last week raised hisestimate on the chances of a Greek departure to 75 percent by theend of 2013 from 50 percent.

Buiter and colleague Ebrahim Rahbari wrote in a report publishedyesterday that the ECB would use its “potentially infinite”resources to restart its sovereign bond-buying program suspended inApril and enact another round of long-term lending akin to the 1.02trillion euros of three-year low-cost loans issued to banks aroundthe turn of year.

Economists at Bank of America Merrill Lynch see a “high” chancethe ECB would also halve its benchmark interest rate from thecurrent 1 percent. The ECB could also follow the example of theSwiss National Bank and announce it is prepared to buy euro- areagovernment debt without limits at a certain yield, say 6 percent,said Brown of Schroders.

ECB Backstop

“After markets had tested the resolve of the ECB and found it tobe firm, I don't think the ECB would end up owning all thesovereign debt,” Brown said. “Suddenly investors would be veryinterested in owning Italian debt knowing the ECB stood behindthem.”

Global central banks may also need to swing into action byopening currency swap lines at cheap borrowing costs to avoidfunding problems, the BofA Merrill Lynch economists said. The Bankof Japan already said today it would deploy its foreign exchangeassets as part of any international emergency response to turmoilin markets.

For governments and regional rescue funds, an “immediate move”would be to ring-fence banks by guaranteeing deposits and providingfresh capital, said Jacob Kirkegaard, research fellow at thePeterson Institute for International Economics in Washington. Spainalone has deposits totaling 1 trillion euros.

One way to ease such efforts would be to hand a banking licenseto the 500 billion-euro European Stability Mechanism, theeuro-area's permanent rescue fund scheduled for life from July,according to David Mackie, chief European economist at JPMorganChase & Co. That would allow it to boost the aid it can provideby borrowing from the ECB, which has resisted such a move in thepast.

Credit lines could also be issued, perhaps in union with theInternational Monetary Fund, for drawing down by troubled countriesif needed, said Holger Schmieding, chief economist at BerenbergBank in London. Governments would have to tell Spain and Italy theycould tap aid without being forced to accept more budgetretrenchment in return.

That “would address the market anxiety that Spain or Italy couldfall into the Greek trap of ever more austerity in response to everbigger tax shortfalls caused by recession,” said Schmieding, whoadded much would depend on the ability of German Chancellor AngelaMerkel and incoming French President Francois Hollande to findcommon ground.

Ties That Bind

Those leaders would also have to forge ahead with efforts tostrengthen political and fiscal ties with the end game being theissuing of joint debt, said Kirkegaard at Peterson. “There willhave to be significant deepening of integration to show where theremaining 16 are going,” he said.

Europe may be more resilient now to a fracturing of the singlecurrency. The region will soon have 500 billion euros of addedfirepower and the IMF is fortifying its own reserves. Greece hasalso restructured its debt with private investors and EU bankholdings of Greek bonds have fallen by more than half from $68billion two years ago, according to the Bank for InternationalSettlements.

“We have had some notice to prepare,” said Mark Cliffe, globalhead of financial markets research at ING Bank NV. “But frankly,most of the mechanisms that transmit the problem beyond Greeceremain in place.”

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