David Makovsky, an expert on Israeli politics, says there is concern that if Prime Minister Ehud Olmert is forced to resign as a result of the investigation into his finances, this could turn "to an unraveling of whatever has been done on the Palestinian issue." In an interview from Israel, Makovsky says Olmert and Palestinian Authority President Mahmoud Abbas were close to some statement of principles that might serve as a document for both sides to ratify on the outlines of a peace treaty. He says that even though both are politically weak, they "actually trust each other and believe the other one wants peace. They've spent a lot of hours talking about these core issues—refugees, land, and security."

May 14 is the sixtieth anniversary of Israel's independence in the Western calendar. President Bush and other dignitaries have arrived. What's the mood in Israel like these days? Is it celebratory or are people rather sober about the tough problems ahead?

It's a mixture. Because of concerns from afar like Iran and from near like Hamas, there is concern about the next threat but the sixtieth birthday is a chance for many Israelis to look back at their achievement. The country in 1948 had 600,000 people; it now has 7 million. Despite all the wars they were able to build a democracy and are now in the OECD [Organization for Economic Cooperation and Development] with a very enviable high-tech sector. There is an element of pride and achievement that is tempered by threats and is also tempered by the current political crisis—the news reports about the investigation into Prime Minister Ehud Olmert's finances.

The news reports I've seen both in the Israeli English-language press and in the American press say it's a bribery investigation, but it's unclear what it is he's been accused of doing.

It's confusing for me and I've been trying to ferret it out. The problem is that the tabloids have screaming headlines and often there's more heat than light. It seems as if he was doing fund-raising for the Likud [Israeli center-right political party]. In that capacity he did fund-raising from abroad. The law has been tightened over time on what sort of campaign contributions foreigners can make to Israel, but Olmert seems to suggest that this had taken place when the law was a little bit more generous. It seems that the issue is whether the money he received was accounted for as part of campaign financing, which still may be illegal but is not the same thing as personal corruption, and whether he is able to account for the funds—much of it apparently in cash. He has insisted emphatically and defiantly that he has not taken a penny for himself and that the issue of the investigation is focused on campaign finances.

Does this impact on the peace talks with the Palestinians?

After meeting with a number of cabinet ministers, members of the Knesset, members of the coalitions, of the Labor party, I can tell you that they almost all are very worried that if he is forced to step down it will either immediately lead to new elections or will lead to new elections after a brief interim government. They feel new elections would lead to an unraveling of whatever has been done on the Palestinian issue. They genuinely believe, and I've talked now to so many of them, that Olmert was very committed and probably was planning on having some sort of document worked out with the Palestinians by August. For them it would be a tragedy for a possible peace between Israel and the Palestinians if he would step down. Others say no, that Foreign Minister Tzipi Livni will pick up where he left off. Some of them are worried that the government will unravel and new elections will be held and that Benjamin Netanyahu of Likud, a critic of the Annapolis process, would emerge victorious in an election.

You've been talking to both Israelis and Palestinians over the last couple of weeks. What is your sense of the situation on these peace talks? Is there any chance at all that Bush's hope to have a peace treaty by the time he leaves office in January is possible?

Basically when people hear the words "peace treaty" they say that Bush is living in a fantasy world. They believe that the best that could be accomplished would be a framework agreement or a declaration of principles that would take note of the basic trade-offs on the core issues that would have to be included. No one has been ridiculed for being a pessimist in the Middle East. But what's happened here is that there is a belief that Olmert and President Mahmoud Abbas, despite both being politically weak, for the first time actually trust each other and believe the other one wants peace. They've spent a lot of hours talking about these core issues—refugees, land, and security.

Let's go through these issues a little bit. Is there any consensus on the refugee issue do you think? The Palestinians on the record insist on carrying out the old UN General Assembly Resolution calling for all Palestinians to have a right to return to their homes and villages in Israel from which they either fled or were pushed out.

I believe that Palestinians understand the refugees will be able to go to a new state of Palestine. No one wants a single refugee to live in squalor. But they won't be able to go to Israel as well as to Palestine. The question is can they enter Israel under some humanitarian unification-of-families program that's not seen by Israel as something that could basically lead to a flood of refugees coming in and changing the Jewish character of Israel. There are formulas here that are being discussed because everyone understands that Israel is not going to open its borders en masse to Palestinians and everyone understands that, of course, the refugees will be compensated for their homes in what is now Israel. Money is not an issue.

What about borders? The Palestinians always talk about returning to the pre-1967 War borders.

In my view, the border issue is something that is eminently doable. I believe that both sides understand that Israel is going to keep settlement blocs that are largely adjacent to Israeli urban areas. Compensating land could be found that would give the Palestinians the feeling that they have gotten a full contiguous state. I also think that is very doable. The issue of security in Jerusalem on the other hand will be a bigger question.

The Palestinians still insist on East Jerusalem being their capital. Is that possible?

This is where you've got to look at Jerusalem as a political city, a religious city, and a functioning city. Any solution has to meet all three tests. There are these neighborhoods on the outskirts of Jerusalem that were basically reincorporated and gerrymandered when Israel won the territory in 1967. Most of those Arab neighborhoods, the average Arab-Jerusalemite doesn't know it's in Jerusalem. Olmert has already said publicly—he's the only minister who was ever the mayor of Jerusalem—that land will be part of the Palestinian state. Those areas are not a question; the question is more of the core Jerusalem, that is, the Old City of Jerusalem, is there going to be sovereignty there? The area right outside of it in the area called the Mount of Olives, some people call it the Holy Basin. What's going to be the sovereignty of that area and particularly contested religious sites like the Temple Mount?

It's very hard for me to envisage the two sides issuing some document that even suggests compromises on Jerusalem, the right of return, and the borders, given that the critics on both sides would simply not accept compromises.

There may be a situation where they don't solve all of their problems but they solve some of them. The question is can you end up in a way where you say that Jerusalem is somehow going to be the capital for both peoples but the contours of this would have to be discussed in state-to-state relations.

Even if Olmert survives, I'm not looking for a document here that solves everything. But it would be good if enough progress is made so that most people in the world would consider it a dramatic breakthrough. I'm not here to say that it will happen because you never know. I definitely want to be clear on the issue of the weaknesses on both sides because people are going to ask this. I reaffirmed this in my meetings that any document Abbas and Olmert produce will not be able to be passed by the Palestinian and Israeli ruling bodies, but would be initialed and would be basically the platform for Olmert and Abbas to run for reelection on. It would have to go through the people and the people will have to decide if that's what they want. If Olmert survives politically there might be some document that maybe doesn't solve everything but does solve a lot of it in a way that would enable these people to go to their peoples and then let the people use the election as a referendum. It would be used as a mechanism for Abbas to confront Hamas: "You don't see yourself as part of al-Qaeda, you see yourself as part of the Palestinian National Movement and I'm bringing a document that could end the occupation. Are you with me or not?"

What is important for people to understand is that both Olmert and Abbas understand one very important point and that is if they cannot find a way to move forward together the alternative to them is radicalization and polarization.

What about security?

What's different today from 2000 when Bill Clinton was at Camp David in the last months of his presidency, is that then there was security cooperation between Israel and the Palestinian Authority. Then no one thought Hamas was coming to power, and then no one saw stand-alone rockets as a threat to cities. All those three assumptions frankly have changed since the year 2000. It seems more likely that Israel, having gotten out of Gaza, doesn't want to see the situation repeated in the West Bank so they are going to be nervous about anything that doesn't give Israeli forces the freedom of movement. The Palestinians will say that international forces, NATO or whatever, should be enough. Israel believes that the international force exercise in Lebanon has not been successful because Hezbollah has rearmed. That issue means in my view that any agreement is going to be an agreement with a phased-in period based on performance. The Israeli fear is that rockets will be able to hit any part of the country. The Palestinians will want to know that they could have a genuine state. The moderates on both sides feel that if they don't come up with something, then the people waiting in the wings are not going to make life easier.