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Bailout ruling

Danhong Zhang / cmk
March 18, 2014

Germany's highest court is always good for a surprise. But this time its ruling, supporting Europe's ESM bailout fund, reflects earlier decisions by lower courts which had already provisionally approved the scheme.

Image: picture-alliance/dpa

"Despite the liabilities assumed, the budgetary autonomy of the German Bundestag is sufficiently safeguarded," said the court in a statement after its chief justice, Andreas Vosskuhle, read out the verdict.

The lawsuit against the ESM was the largest constitutional complaint in German history: In June 2012, several professors and legislators, joined by more than 37,000 private citizens, filed suit against the European Stability Mechanism (ESM) before Germany's Federal Constitutional Court.

"The federal government and the parliament are responsible for Germany's finances. And the Federal Constitutional Court has already ruled in previous cases that [German law] prohibits the automatic financial burden-sharing of other countries' debts in the European Union," said Joachim Starbatty, a retired economics professor at the University of Tübingen and one of the plaintiffs. The bailout scheme is an instrument that has simply prepared the way for a socialization of debt, he told DW in an interview.

Specifically, the plaintiffs fear that the ESM - with its current lending volume of 500 billion euros ($696.9 billion) - could be automatically extended in an emergency, undercutting the German parliament's constitutional right to approve or reject all budgetary decisions that affect Germany.

A 'yes, but…' ruling

Germany's highest court ruled differently, arguing that the German parliament remained the relevant authority because of an ESM law which was passed parallel to the ESM treaty. The constitutional justices handed down one of their typical 'yes, but' verdicts on matters of European integration: Yes, the ESM was constitutional, but only under the condition that Germany's liability be limited to 190 billion euros ($264.8 billion) and that any further liabilites had to be approved by parliament.

So far, so good, except that just a week before the ruling in that fateful September 2012, the European Central Bank introduced its so-called Outright Monetary Transactions (OMT) program. With this program, the ECB gave itself permission, in an emergency, to buy unlimited amounts of bonds from crisis-hit EU member states. This program dwarfed all previous 'big gun' financial instruments at its disposal and promptly reassured financial markets.

Jürgen Matthes Institut der deutschen Wirtschaft Köln
Jürgen Matthes: Surprised by the opinion of the Constitutional CourtImage: Institut der deutschen Wirtschaft Köln

But what had served to keep the euro crisis in check ended up sparking a storm of indignation in Germany. The ECB was financing national budgets and wildly overstepping its mandate, the critics said. Here, too, the German Supreme Court reserved the right to pass judgment on the OMT program.

A 'no, except…' opinion

Then, in February, came the surprising announcement from the High Court to first refer the case to the European level. It asked the European Court of Justice (ECJ) to check whether the bond purchase program constituted a breach of EU treaties. The fact that, in the eyes of the Constitutional Court, the ECB had exceeded its mandate was made clear in the court's written opinion.

"I think we were very surprised by the opinion of the Constitutional Court because it very clearly placed itself on the side of the plaintiff," said Jürgen Matthes of the Cologne Institute for Economic Research (IW). The judges had broken their familiar "yes, but…" pattern, instead going with "no, except…" "The statement made it clear that if the program is not changed, then it can't be considered to be a true mandate for the ECB," Matthes told DW.

The program could be amended to ensure that it was limited in both its timeframe and scope of bond purchases. But doing so would take away its firepower, which we have to thank for the current calm in the eurozone, he said.

Monetary policy or fiscal policy?

But that calm is deceptive, say critics of the ECB, because the root causes of the crisis have not been eliminated. The economic imbalances in the eurozone continue, even if the differences in interest rates on government bonds, also called interest rate spreads, are artificially reduced by the ECB. These differences are reflected in the different risks.

"And, importantly, the German Constitutional Court has said that if the ECB gets into interest rate spreads, then it is no longer engaging in monetary policy but fiscal policy because it wants to reduce interest rates for distressed debtor states," said Starbatty. He is pleased that the high court justices have accepted this position of the plaintiffs.

Joachim Starbatty
Starbatty is one of the main plaintiffs in the suit against the ESM bailout fundImage: picture-alliance/dpa

IW's Matthes, however, believes the Court has leaned too far out the window. "It has moved onto economic terrain, ignoring the fact that financial markets are quite capable of irrationally overreacting" thereby driving previously solvent states into bankruptcy.

But this is exactly what the role of the ESM should be, argues Matthes: to come to the rescue of solvent states in such a situation. Is the ESM not just duplicating the ECB's OMT program? Is the difference not just in the fact that the ESM is subject to democratic legitimation and therefore could not act fast enough in an emergency?

Matthes says 'no'. The objective of the two instruments is different, even if both reach into the realm of government bonds and produce a similar effect. For the ECB, its monetary policy is meant to provide financial aid to crisis countries, while the ESM operates in the realm of fiscal policy by intervening directly on the government bond market.

Splitting the proceedings

If this all sounds a bit too complicated, it should come as no surprise that the Constitutional Court has decided to separate the issues of the OMT and the ESM in the main proceedings. In the judgment on the bailout expected on Tuesday (18.03.2014), it will only be a question of whether the budget law supremacy of the German parliament is being undermined.

"This has already been dealt with in the preliminary verdict. And, as the court has already said that it is acceptable as long as any increase in liability is approved by parliament, I'm not expecting any new findings," said Starbatty.

The suspense will continue, then, until the European Court of Justice has expressed its opinion on the OMT program and, in turn, Germany's Constitutional Court then makes its final judgment. Either the ECJ restricts the OMT program, thereby limiting its impact, or the ECJ sees the bond purchase program as fully justified. Should that happen, then the German Constitutional Court would have to make a 180-degree turn, although this is unlikely.

But, if that were to happen, warns Matthes, "then we [would be] in a situation in which we either change the constitution or possibly European treaties, or where, in the end, the Bundesbank is more or less forced out of the monetary union." That, he stressed, would ultimately mean a German withdrawal from the monetary union.