Friday, November 28, 2014

Judgment Day for the Eurozone

MUNICH – Europe and the world are eagerly awaiting the decision of Germany’s Constitutional Court on September 12 regarding the European Stability Mechanism (ESM), the proposed permanent successor to the eurozone’s current emergency lender, the European Financial Stability Mechanism. The Court must rule on German plaintiffs’ claim that legislation to establish the ESM would violate Germany’s Grundgesetz (Basic Law). If the Court rules in the plaintiffs’ favor, it will ask Germany’s president not to sign the ESM treaty, which has already been ratified by Germany’s Bundestag (parliament).

There are serious concerns on all sides about the pending decision. Investors are worried that the Court could oppose the ESM such that they would have to bear the losses from their bad investments. Taxpayers and pensioners in European countries that still have solid economies are worried that the Court could pave the way for socialization of eurozone debt, saddling them with the burden of these same investors’ losses.

The plaintiffs represent the entire political spectrum, including the Left Party, the Christian Social Union MP Peter Gauweiler, and the justice minister in former Chancellor Gerhard Schröder’s Social Democratic government, Herta Däubler-Gmelin, who has collected tens of thousands of signatures supporting her case. There is also a group of retired professors of economics and law, and another of “ordinary” citizens, whose individual complaints have been selected as examples by the Court.

The plaintiffs have raised several objections to the ESM. First, they claim that it breaches the Maastricht Treaty’s “no bail-out” clause (Article 125). Germany agreed to relinquish the Deutsche Mark on the condition that the new currency area would not lead to direct or indirect socialization of its members’ debt, thus precluding any financial assistance from EU funds for states facing bankruptcy. Indeed, the new currency was conceived as a unit of account for economic exchange that would not have any wealth implications at all.

The plaintiffs argue that, in the case of Greece, breaching Article 125 required proof that its insolvency would pose a greater danger than anticipated when the Maastricht Treaty was drafted. However, no such proof was provided.

Second, Germany’s law on the introduction of the ESM obliges Germany’s representative on the ESM Council to vote only after having asked the Bundestag for a decision. According to the plaintiffs, this is not permissible under international law. If Germany had wished to constrain its governor’s authority in this way, it should have informed the other signatory states prior to doing so. On the other hand, Germany’s representative on the Governing Council is sworn to secrecy, which, the plaintiffs argue, precludes any accountability to the Bundestag.

Moreover, the plaintiffs claim that, while the ESM treaty is restrictive in granting resources to individual states, requiring a qualified majority vote, it does not specify the conditions under which losses are acceptable. Losses can result from excessive wages paid by the ESM Governing Council members to themselves, a dearth of energy in efforts to collect debts from countries that have received credit, or other forms of mismanagement. And, because Governing Council and Executive Board members enjoy immunity from criminal prosecution, misbehavior cannot be punished.

If losses arise, they must be covered by the initial cash contribution of €80 billion ($100 billion), which then would be topped up automatically by all participating countries according to their capital shares. If individual countries are no longer able to make the necessary contributions, others must do so on their behalf. In principle, a single country might have to assume the entire burden of losses. Such joint and several liability, the plaintiffs assert, contradicts the Court’s previous statements that Germany should not accept any financial commitments stemming from other states’ behavior.

Worse, according to the plaintiffs, although the liability of any country vis-à-vis external partners is limited to that country’s share of capital, this limitation does not apply to other signatory states. It is theoretically possible that a single country could be held liable for the ESM’s total exposure of €700 billion.

Finally, the ESM cannot be considered on its own, but must be seen in the context of the total exposure amount, which includes the €1.4 trillion in bailout funds that have already been granted. In particular, the Target2 credit drawn by the crisis-afflicted countries’ central banks, which already totals almost €1 trillion, should also be taken into consideration.

Nobody knows how the Constitutional Court will rule on these objections. Most observers believe that the Court is unlikely to oppose the ESM treaty, though many expect the judges to demand certain amendments, or to ask Germany’s president to make his signature subject to certain qualifications.

It is good that the Court’s decisions cannot be forecast, and even better that the Court cannot be lobbied or petitioned. The European Union can be based only on the rule of law. If those in power can break its rules on a case-by-case basis, the EU will never develop into the stable construct that is a prerequisite for peace and prosperity.

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    1. Commentedde Lafayette

      { It is theoretically possible that a single country could be held liable for the ESM’s total exposure of €700 billion.}

      This remark is pure fantasy. It is amazing to see it even in print. No country, big or small, could or therefore would be obliged to pay that amount of money.

      Unless, of course, the perpetrators of such are seeking the break-up of the EU. Which makes one wonder ...

    2. CommentedPieter Keesen

      Buy Euro put and call options on the money for the month of September, perhaps rolling over into October November. The Dutch go to the ballots on the 12th too, which basically constitutes a referendum on the Euro. The Greeks need more time to save their budget, awaiting the report of the Trojka early October. The ECB is likely to start buying Southern European debt sooner rather then later. The hidden risk of the target2 imbalances slowly emerge from the shadows. The US elections are due, the middle east is ready to explode any minute now. If you work and Goldman Sachs, it is time to make money.

        Commenteddalai guevara

        Pieter - the Dutch will not spoil the party, so much is certain.

        The ECB aready has begun to by S-EU debt. What do you think that Greek auction 2 weeks ago was all about? Furthermore, there is not a single Greek bond out there anymore, as they went bankrupt THREE years ago and have since been supported.

        The remainder of your post is quite frankly cryptic and fails to apply basic rules of causality, so only this much:

        there are more positive-thinking supporters of the European idea out there than you think. The ECSC/EEC/EU/Eurozone have moved fast within the short lifespan of my cognitive memory, they will continue to successfully tackle the issues they are now facing.

        Bet against them on the Anglo-American derivative gambling market - all you are doing is digging your own grave. You and I know full well - this is first and foremost a 'CDS crisis'.

    3. CommentedProcyon Mukherjee

      Socialization of member's debt if it is either put on vote or put for Court's verdict would probably have the same sensitivities to deal with as elaborated in the article. It indeed could boil down to one country assuming the entire burden of losses, without any backstop, which obviously needs a painful correction either way; but the least we can expect is not a free-riding solution where moral hazard is established once and for all.

      Procyon Mukherjee

    4. CommentedZsolt Hermann

      The plaintiff, and most of everybody else, still do not understand how interconnected and how interdependent we all are.
      We cannot simply "let someone go" because there is "no someone else" but a single, united human mass.
      We are all sitting on the same sinking boat, the problems we are facing we all created together, for example the way the Eurozone functioned until the wheels came off was much more profitable for the Germans, and other strong economies than for the "weaker Southern countries. Paradoxically throwing out the ballast would cause the balloon to fall rather then fly.
      There is no "me and you", "we and them" any longer, we evolved into a global, integral system where we are all tied together like mountaineers.
      If one falls everybody else falls.
      The only thing we can do is to introduce a global, integral education so everybody understand the full meaning of the global human network, the full extent of our interdependency and then based on that knowledge we can build a new socio-economic structure operating on mutual responsibility and consideration.