08 February 2014

German court refers ECB bond-buying to ECJ

As reported by the Financial Times (subscription), nearly two years after Mario Draghi announced he would do "whatever it takes" to save the euro, it is still unclear whether it was lawful for the European Central Bank president to make that pledge. On Friday, after a year-long scrutiny, the German constitutional court said that the ECB’s "outright monetary transactions" programme – the bond-buying scheme that made good on Mr Draghi’s promise – went beyond the central bank’s mandate. The supreme court also referred the matter to the European Court of Justice. While few imagine the ECJ will rule against this flagship policy, the political controversy around the programme, especially in Germany, will persist. 

In the official press release, the court communicated: "While the Senate is thus inclined to regard the OMT Decision as an ultra vires act, it also considers it possible that if the OMT Decision were interpreted restrictively in the light of the Treaties, conformity with primary law could be achieved. The Senate decided with 6:2 votes; Justice Lübbe-Wolff and Justice Gerhardt both delivered a separate opinion." The latter two dissented from the ruling on the grounds that the case was inadmissible. One said that monetary and economic policies related to each other and could not be strictly separated, and argued that the ECB’s insistence that OMT was intended first and foremost to restore the monetary transmission mechanism could not be brushed aside so unequivocally, reports the Economist.

The judges in Karlsruhe argue that OMT goes against the ECB’s mandate since it amounts de facto to monetary financing of government debt – which is prohibited under article 123 of the European Treaty, explains the Financial Times (subscription). This is also the position of the Bundesbank, Germany’s central bank, which has consistently opposed OMT. In the view of the Federal constitutional court, the objective mentioned by the ECB to justify the OMT decision, namely to correct a disruption to the monetary policy transmission mechanism, cannot change this assessment, writes the Telegraph. As reported by Wall Street Journal (subscription), the challenge was brought by a loose coalition of economists, law professors, left-wing eurosceptics and conservative libertarians.

The ECB has long seen a referral to the European court as the most favourable realistic outcome. It is keeping the bond-buying programme in place pending the review in Luxembourg. On average, the ECJ takes some 16 months to reach a judgement, allowing time for Member States and EU institutions to be heard. In special cases, the referring party—in this case Germany's constitutional court—or the ECJ's president can request an accelerated procedure, which could allow a judgement within four to six months.

The Telegraph writes that the "ECB was paralysed by the German court's decision as deflation threatens. The 'thunderbolt' ruling on eurozone rescue policies by Germany’s top court marks a serious escalation of Europe’s governance crisis and may ultimately force Germany to withdraw from the euro, the newspaper quotes Germany's most influential magazine, Spiegel. It further said the court ruling amounts to a full-blown showdown between Germany and the European Central Bank over the methods to shore up southern Europe's debt markets.

Reactions

The ECB's Benoît Cœuré said in an interview with Thomson Reuters: "We're not commenting on court decisions. This case has been reviewed by the court. It will now be reviewed by another court, ECJ. We certainly stand ready to cooperate with the European Court of Justice and explain what we've been doing. The OMT is a programme that the Governing Council of the ECB has designed in a way that make it both efficient and safe legally, so we firmly believe that the OMT is safely within the remit of the ECB in terms of being monetary policy and in terms of not being monetary financing of governments. We have ourselves set a number of limits to the programme to make sure we are on the safe side. The status of the OMT is not changed. It is ready to be used but it is highly unlikely it would have to be used at the moment."

The German government took note of the Federal Constitutional Court’s decision to refer the question to the European Court of Justice for a preliminary ruling. The European Central Bank has said that activation of the programme would be linked to an ongoing EFSF/ESM programme involving strict conditionality and the option of purchases on the primary market. In the oral hearing, the Federal Government explained that it expressly reserves its approval for this kind of programme. The Federal Government also argued before the Federal Constitutional Court that the aspects raised by the complainant regarding the ECB’s bond-purchase programme fall within the remit of the European Court of Justice. The splitting of the proceedings that has now occurred makes it possible, on the one hand, swiftly to achieve legal certainty regarding the other open questions relating to the European Stability Mechanism while on the other hand allowing the interpretation of European primary law to be carried out by the European Court of Justice.

Press release

The German Finance Minister has played down the damage of the ruling that the powerful ECB tool could be unconstitutional, reports the Telegraph. Wolfgang Schäuble said that although the ECB's most effective tool for calming the eurozone debt markets, unlimited bond-buying, could be ruled illegal by the European Court of Justice, financial markets are now confident that the eurozone will remain intact. Some experts, including the head of Germany's ZEW think tank Clemens Fuest, have said the court decision severely blunts the OMT programme, reports Reuters. But Schäuble dismissed those concerns, saying the details of the OMT were secondary to the broad message sent by the ECB and European governments that they would not let the eurozone break apart.

ECB Governing Council member Erkki Liikanen is quoted by Reuters as having said that the programme was "totally compatible with our mandate". He said emerging market turmoil could last some time but added that "the euro area has been quite resilient to this turbulence". 

EU economics chief Olli Rehn says German court has not emasculated the ECB's ultimate weapon, reports the Telegraph. The European Central Bank still has a "big bazooka" with plenty of ammunition to preserve the euro despite a German constitutional court statement that its bond-buying plan is probably illegal, he said. The European Commissioner for Economic and Monetary Affairs said it was right that a European court, not a national court, should have the final say over the ECB's actions.

German eurosceptics celebrated the result. "Finally, a court has found that the ECB’s bond-buying programme is a clear violation of European law", said professor Bernd Lücke, head of the AfD anti-euro party, reports the Telegraph.

"Germany’s constitutional court has strengthened the eurosceptics", writes Wolfgang Münchau for the Financial Times. He argues that it would be wrong to interpret the ruling of the German constitutional court as "having caved in" by referring the case to the ECJ. The court concludes clearly, he writes, that OMT violates the German constitution. It accuses the ECB of making a power grab by extending its own mandate. It says the scheme endangers the underpinnings of the eurozone rescue programmes. Worse, it says OMT undermined deep principles of democracy.

Paul Taylor analyses for Thomson Reuters that the court's ruling leaves the sovereignty issue unresolved. It was the first time the judges in Karlsruhe had referred any case to the ECJ for a preliminary ruling, but in doing so they avoided acknowledging the supremacy of European treaty law over the national constitutions of Member States. They did not spell out what they would do if the European court determines that the ECB was within its rights, as German Finance Minister Wolfgang Schäuble and the ECB both argued in testimony at a Karlsruhe hearing last year.

Think Tanks

Jacob Funk Kirkegaard argues for the Peterson Insititute for International Economics that the German establishment was "principled but pragmatic". The ruling on the OMT, he writes, rescues the German government—which repeatedly has expressed its political support for the OMT—from a political headache and potential requirement to change the German constitution, which the ruling Grand Coalition has the votes to carry out. Second (as reflected also in the two dissenting votes on the court), the ruling rescues the Constitutional Court from charges of judicial activism and infringement on the right of the German parliament to exercise discretion in its policymaking.

In German jurisprudence, it seems questionable, even if the Constitutional Court has a mandate, to go so directly against a repeatedly re-elected super majority of the German Bundestag. Now instead, a majority of the Constitutional Court gets to adhere to its narrow legal principles, safe in the knowledge that it will have very little real world impact. In addition, the still latent interventionist streak implied by the German court helps Chancellor Angela Merkel draw some more credible red lines for what Germany can accept in the European Union and thereby strengthens her negotiating hand with the rest of the member states. In the German political establishment, every institution has its role to play—but it is rarely the one reported in the press.

Full article © Peter G. Peterson Institute for International Economics

Guntram B Wolff writes in a brief for Bruegel that de facto, Karlsruhe suggests that the ECB is a preferred creditor. A priori, this appears to be a sensible point as otherwise the likelihood of monetary financing could increase. However, it could also mean that the exit from an ESM/OMT programme could be very difficult. In fact, private creditors would understand that they are subordinate to the ECB and would require a much higher yield depending on the relative size of the ESM programme, the OMT purchases and the remaining debt in private hands. De facto, this could mean that even if overall debt is sustainable, a programme exit is not possible because the subordination precludes market access. As a result, PSI or an OSI on the official lending may become more likely in order to bring a country back to the market. It will be of central importance, whether the ECJ confirms the seniority of the ECB.

Full article © Bruegel 2014

Marcel Fratzscher, President of the German Institute for Economic Research (DIW Berlin) argues for Project Syndicate that until the ECJ confirms the GCC's decision, "outright monetary transactions" (OMT) scheme is effectively dead, weakening the ECB’s ability to act as an effective and credible financial-market backstop at a time when European governments remain unwilling to fill the void. According to the court, the scheme can be legal only if it is limited in size ex ante, rules out losses on sovereign debt, and avoids "interferences with price formation on the market". The problem is that almost all ECB policies would violate these principles, which is why the ruling represents a severe setback for Europe, he writes. The German court’s ruling jeopardises the ECB’s ability to act as an effective lender of last resort, thereby reducing its independence and ultimately undermining its ability to deal with market panics and crises – and thus to fulfil its primary mandate of price stability. The ruling makes it more urgent than ever that European governments establish a viable and effective banking union and strengthen the ESM as a backstop for countries in crisis.

Full article © Project Syndicate

See also Graham Bishop's blog, 10.2.14