Germany’s Constitutional Court is preparing what might become the most important decision in its history. Last September, the court allowed the German government to sign the Treaty establishing the European Stability Mechanism (ESM), the eurozone’s permanent intergovernmental rescue facility. Now, however, it may try to stop the European Central Bank’s so-called outright monetary transactions (OMT) program (the ECB’s pledge to buy, without limit, the government bonds of troubled eurozone countries that subject themselves to the ESM’s conditions).
To be sure, the German court has no jurisdiction over the ECB – and thus has no power to judge its actions. The only institution that does have that power is the European Court of Justice in Luxembourg. But Germany’s Constitutional Court can judge whether the actions of EU institutions are compatible with its constitution and the European Union treaties.
If the court finds that the ECB’s actions are unlawful, it can constrain German institutions – even the German parliament. For example, it could forbid the Bundesbank from participating in the OMT program. Or it could rule that the German government’s participation in the ESM be conditional on the ECB’s willingness to limit OMTs. Udo di Fabio, a renowned former judge on the court, has argued that the tribunal could even force the German government to unwind the EU treaties if it does not succeed in curbing the OMT program.
The OMT program’s supporters point out that it has calmed the financial markets by affirming the ECB’s readiness to step in as a lender of last resort and buy sovereign debt before a country goes bust. By driving the market to a so-called “good” equilibrium, such a country’s yields remain low, and it can continue to borrow. They point out that central banks all over the world are undertaking similar actions to stabilize markets. The Federal Reserve, in particular, has bought huge quantities of US government bonds.
Opponents point out that that is exactly the problem, because the ECB’s mandate is more limited than the Fed’s. After all, the eurozone is not a federal country, and the Treaty on the Functioning of the European Union (article 123 in particular) explicitly forbids monetary financing of the member states, which was Germany’s condition for giving up the Deutschmark. Moreover, the opponents argue, even the Fed does not buy bonds issued by US states, such as California or Illinois.
Proponents of OMT counter that the Treaty forbids only direct government bond purchases; indirect purchases in secondary markets are allowed. But the decision not to prohibit indirect purchases, opponents argue, may have been intended to allow the ECB to carry out weekly repo operations, following a practice used by the Banque de France to reduce fluctuations in short-term interest rates. It was not a mandate to buy, or announce to buy, sizeable stocks of bonds in order to reduce long-term interest rates.
Moreover, not forbidding indirect purchases should be seen primarily as a means of permitting banks that buy government bonds to pledge them as collateral for refinancing operations, while bearing the full investment risk. The distinction between bond purchases from the government and from banks that bought them from the government is a phony one that gives rise to myriad possibilities for circumvention.
A major concern of the German Constitutional Court is the similarity between the ESM’s Secondary Market Support Facility (SMSF) and the ECB’s OMT program, both of which imply the purchase of government bonds in secondary markets. The two schemes are being carried out under nearly identical conditions – requiring the ESM’s approval of a country’s reform program – and neither has been triggered so far.
But the SMSF’s ability to provide financing is indirectly capped by member states’ maximum liability at 700 billion euros (925 billion dollars); after the Constitutional Court excluded joint and several liability in its September 2012 ruling, Germany’s maximum liability stands at 190 billion euros. By contrast, the OMT is unconstrained. Because ECB losses result in seignorage losses for the respective national treasuries in a way similar to ESM losses, the OMT obviously undermines the ESM ruling by increasing the liability risk beyond the level approved by parliaments.
The similarity between the SMSF and OMTs also implies that at least one of the two institutions is exceeding its mandate. If government-bond purchases are monetary operations, as the ECB claims, the ESM is overreaching; if they are fiscal operations, it is the ECB that has crossed the line.
According to this logic, at least one of the institutions is acting unlawfully. Because the Constitutional Court has already given a green light to the ESM’s SMSF program, how it will rule on the OMT program should be clear. However, in courts, as in the open sea, predictions often prove unreliable.
Professor of Economics and Public Finance, University of Munich,
President of the Ifo Institute
Published under the title “Eine historische Entscheidung”, Handelsblatt, No. 127, 5/6/7 July 2013, p. 64; and in an abridged form under the title “Germany’s Case Against the ECB”, Project Syndicate, 25 June 2013.