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No ESM? What then?

Bernd Riegert / gsw
September 11, 2012

What might happen if Germany's Constitutional Court blocks the ESM, the planned permanent rescue fund for the eurozone? Is there a plan B? Ahead of the ruling expected Wednesday, speculation is growing.

An EU flag shines through the cutout letters ESM Photo: Franziska Kraufmann dpa/lsw
Image: picture-alliance/dpa

The European Stability Mechanism (ESM) still doesn't have a telephone number or a website. But it does have a boss: Klaus Regling. He's a senior German official who currently heads the provisional European Financial Stability Facility (EFSF) based in Luxembourg. Once the ESM is officially established, Regling will lead the permanent euro zone rescue fund, though he has been reticent about the preparations being made for the transition.

From Luxembourg, the word is that the ESM could begin its work by the end of October provided at least two conditions are met. First, Germany's Constitutional Court must rule that the ESM's provisions are consistent with the German constitution. In turn, the German government would have to ratify the establishment of the stability mechanism.

Furthermore, the 17 euro zone member states must have offered 90 percent of their own contributions, totaling 80 billion euros ($102 billion). Since Germany is responsible for providing around 27 percent of that capital, much depends on the Constitutional Court's verdict, expected Wednesday (12.09.2012). Along with Ireland, Germany is the only country that has not yet ratified the ESM contract.

Chaos or a little stumbling block?

Experts are divided on what would happen if the ESM cannot come into effect. If that happens, Carsten Brzeski, the chief economist of DIBA Bank within the Dutch financial group ING, believes investors will grow very uncertain.

"We'll see major chaos. We'll see the financial markets go absolutely haywire," Brzeski told German radio broadcaster Deutschlandfunk. "And that will cost Germany more than the whole project of saving the euro."

Interest rates on Spanish and Italian bonds would also skyrocket, Brzeski said.

Some EU diplomats speaking on condition of anonymity sketched a less alarming scenario. If the permanent ESM were voided, they said, the provisional EFSF would be able to continue its work until the summer of 2013. However, the ESM has important advantages over its forerunner, such as clearer structures and the more secure legal status of being an international financial organization. In Luxembourg's legal framework, the existing EFSF is viewed simply as a private firm created as an emergency measure by EU nations in May 2010.

EFSF could continue

The EFSF still has money in its coffers to support countries like Cyprus or Spain, noted Michael Meister, deputy chair of the conservative governing coalition in the German parliament, in an interview with the German newspaper Welt am Sonntag.

"We still have the provisional EFSF, and there are still 100 to 200 billion euros left in it. So the euro will not collapse one way or another on Wednesday," Meister said.

If the ESM cannot come into effect, there could be other options. Many economists believe that the European Central Bank (ECB) would jump in. The bank announced last Thursday (06.09.2012) that it would be prepared to buy unlimited amounts of bonds from cash-strapped states.

"Now we have unlimited liability via the ECB. That limits the significance of the upcoming decision," said Kai Carstensen of the Munich-based economic research institute Ifo in an interview with the financial newspaper Handelsblatt.

Filling in the gaps

German parliamentarian Klaus-Peter Willsch of the Christian Democrats also takes a measured view of the court ruling's importance, telling Deutschlandfunk that there was now no reason for the judges not refuse their approval.

"You could perhaps tell them that, now that the ECB can take care of the whole problem without political control and responsibilities, the ESM is less essential than ever," said Willsch, who has earned a reputation in parliament as a "euro-rebel" who regularly votes against the rescue packages and rejects the ESM on principle.

Those positions put Willsch at odds with his party's leaders, including Chancellor Angela Merkel, who said in August that the ESM is of the greatest importance when it comes to stabilizing the euro zone. As it stands now, the ECB has said it will only offer its bond-buying scheme to states that have applied for aid from the ESM. But it's unlikely that, even if there should be no ESM, the ECB would let Italy and Spain rely on its buying their bonds without setting other conditions instead.

German Finance Minister and fellow Christian Democrat Wolfgang Schäuble has made optimistic remarks about the impending court ruling, noting that the court has so far done nothing that would block European integration. But it remains to be seen whether, this time, the court views the ESM as going too far.

Constitutional Court President Andreas Vosskuhle Photo: Michael Latz/dapd
Some now see diminished importance for the court's decisionImage: dapd
President of the European Central Bank Mario Draghi (Photo:Yves Logghe/AP/dapd).
ECB President Draghi has announced a bond-buying schemeImage: AP
Klaus Regling, chief executive of the European Financial Stability Facility at a press conference (ddp images/AP Photo/Ng Han Guan)
Current EFSF head Klaus Regling may soon be at the helm of the ESMImage: AP
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