German Constitutional Court Ruling Market Positive…Or Is It?
September 14, 2012 10 Comments
On September 12th, the German Constitutional Court deemed European Stability Mechanism (ESM) legal, paving the way for Spain and potentially Italy to request official support in the bond markets. The Constitutional Court’s ruling was not a carte blanche approval of the ESM’s original legislation, but rather the court demanded a few key changes to the ESM legislation, which could prove extremely important down the line.
First, the German court demanded that Germany’s contribution to the ESM be clearly capped at €190 billion. In doing so, the German Constitutional Court ruling removed some potential loopholes for increasing the overall lending ceiling of the EU’s bailout funds. In particular, it ruled out countries issuing ESM shares above par to increase the overall size of the bailout fund.
Secondly, the Constitutional Court made clear that if Germany wants to make any changes to the ESM, including its liabilities to the bailout fund, both houses of the German parliament must vote in favor of the change. Furthermore, the Bundestag must be kept apprised of how the ESM funds are being used. Given the German parliament’s oversight of changes to the ESM and increased transparency in how the fund is being used, the German court ruled that the ESM does not violate Germany’s constitution as German politicians retain control over budget policy and autonomy has not been ceded.
These conditions set by the German Constitutional Court may come back to haunt the Eurozone. The EFSF and ESM have a lending ceiling of EUR500 billion. Of this, EUR100 billion has already been earmarked for Spanish banks. The EFSF/ESM can purchase up to 50% of new debt issuance in the primary markets for those countries that have requested official support and submitted to the requisite conditionality. If Spain and Italy request primary market purchases from the EFSF/ESM to help them meet their financing needs and the EFSF/ESM purchase the maximum amount allowed, the bailout funds will run out in 2014.
Then what? The German Constitutional Court has just very clearly limited Germany’s contribution to the bailout funds, and the only way to raise Germany’s liabilities is if both houses of parliament vote in favor of it. This seems a long shot. If the lending ceiling of the bailout funds is not raised, then Spain and Italy will be forced to opt for a bail in rather than a bail out. The market response to the German Constitutional Court ruling on the ESM ruling has been positive, but they may not be considering the market implications of this ruling a few years down the line.
This piece first appeared as a feature story in Open Markets and has been republished with their permission.
Megan Greene is the Chief Economist at Maverick Intelligence, with a particular focus on Europe. She is also a senior fellow at the Atlantic Council, a columnist with Bloomberg and a senior research fellow at Trinity College Dublin. The opinions expressed here are her own and do not reflect those of any employers. Ms Greene offers a strictly independent voice without a political or investment agenda.
Megan, do you stick with your comments on Newsnight six months ago that the amounts of money needed to bail out Spain and Italy would exhaust all conceivable bail out funds? Will Hutton said a year ago that two trillion Euro would be required, and you’re saying that in the event of perfectly foreseeable circumstances the current fund will run out in two years. What happens when austerity makes work useless, even for those who are lucky enough to be in employment? What happens when the bail outs stop working because the conditionality is impossible? That’s when the banks topple. Sorry to be a miserabilist, but I can’t see a good outcome to all this. Do you agree we are about two years from disaster?
Wiz, I’d be pleasantly surprised if disaster proves to be as long as two years away.
Megan – perhaps another significant feature was the Court’s unusual and explicit detour into whether the ESM could be legally permitted to receive ECB funds if it were given a banking license. The answer was a clear ‘no’ as they argued this would be a back-door way of breaching the prohibition on ECB directly funding state entities. This was really a question for the European Court of Justice and one that the German Court would not normally engage with. The fact that they chose to do so – although not legally binding on any EU officials – will send a strong message about the legal perils of going down that route.
A strong message it may or may not be, but it is a strong message from a position of weakness. Germany may well be the first country to leave the Euro, and if Merkel stands for re-election next year she will do so as a chancellor who wants to impose a wholly unenforceable austerity on the weakest nations in the union. The Germans are footing the bill at the moment, but my basic and oft-repeated point is that we are only looking at the moment at what the institutions of state are saying, and the actions of governmental executives. They are really not important. Germans don’t believe ordinary Greek people should be punished. And they know that Germany can’t foot the bill for the whole continent. The great advantage of Europe for the Germans has been a wholly unrealistic exchange rate, and the best potential solution is for Germany to become less competitive. But that is why the Germans are still there. The whole edifice is trembling, and I’m not just talking about the institutions of Europe. The people will start voting with their feet and wallets, and at that stage the courts and governments and central banks will have had it.
Thank you.
One question though:
Why drawing such a direct link between the 190bn ceiling (i.e.27% of 700bn of authorized capital or the “overall size” of the fund as you call it) and the lending capacity (500bn based on the 15% ratio between total paid-in capital (80bn) and outstanding amount of ESM issuance)?
I do not see any formal link between the authorized capital (700bn initially) and the total lending capacity (500bn) in the ESM Treaty. Both levels are revisable at unanimity of the Board of Governors. So ok ruling explicitly states that German Parliament has a veto right on the former amount (700bn of authorised K) but what about the latter: the lending capacity and hence the paid-in capital?
Can Schaüble possibly decide on its own to increase the lending limit or does it necessitate Parliament consent? Could finance ministers decide to double the amount to 1000bn and commit and extra 80bn of paid-in capital? I am not sure about the answers but the ESM ruling is not adressing these questions directly.
I would be pleased to read you about this,
Thanks again for your contribution,
krgds,
Xavier Vanden Bosch
The complete documentation about the decision of the German Constitutional Court http://www.robertmwuner.de/verfassungsbeschwerden_esm.html
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Megan, I have a questions please.
I would have thought that the run on the Greek banks would continue, but for the last couple of months it seems to have stopped.
http://www.bankofgreece.gr/Pages/en/Statistics/monetary/deposits.aspx
I am looking at line item 1.2.
Could you explain this please?
Michael
The sentiment in Athens when I was there 3 weeks ago has certainly improved since the July election. I think everyone is relieved that the current coalition is still standing–in doing so it has outdone many people’s expectations already.
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