Germany’s supreme court will rule on whether the ECB has the authority it has claimed under “Outright Monetary Transactions” to do “whatever it takes” to save the euro.The tool was never used, but caused quite a stir.
In response to a class-action lawsuit brought by some 11,000 enraged German plaintiffs, Germany’s Constitutional Court will on Tuesday decide on the legality, under Germany’s basic law, of an impressive superpower the European Central Bank (ECB) has claimed since 2012.
That superpower consists of an ability to stop eurozone gov ernments teetering on the edge of bankruptcy from falling over the edge, by the simple expedient of using the infinitely flexible balance sheet of the central bank to buy those governments’ bonds in whatever quantities needed to keep them financially afloat.
This ECB guarantee, made in late July 2012, immediately had the magical effect of calming bond markets to such an extent that southern European governments now have lower interest rates on their bonds than the US or Japan. Before announcing OMT, countries like Greece, Italy, Portugal and Spain had seen the interest rates on their newly issued bonds spiral out of control. They were headed for insolvency.
The ECB not only claims it has this magical bond-buying superpower – it has set up the tools to enable its practical implementation. In August and September 2012 it set up a special program called Outright Monetary Transactions, or OMT, specifying how – and under what conditions – it would buy the bonds of troubled eurozone governments.
Crucially, the ECB achieved the desired outcome – i.e. stopping private bond markets from doubting the solvency of governments like Italy or Spain, and consequently charging them unsustainably high interest rates – without ever buying a single bond under OMT.
The Germans’ great love: rules
It will be surprising if Germany’s Constitutional Court decides the OMT program is unconstitutional, thereby potentially throwing the finances of several European governments into a tailspin by making it impossible for the ECB to guarantee those governments’ solvency as their lender of last resort.
The reason it would be surprising is that the European Court of Justice ruled in June 2015 that OMT is legal.
If the German court contradicts that ruling, it would throw a huge spanner in the works of European finances, and could – probably would – generate a renewed solvency crisis affecting several eurozone governments. The scarlet-hatted justices in Karlsruhe (picture at top) are unlikely to want to shove several European countries over a cliff, especially just two days before the UK’s vote on whether or not to leave the European Union (“Brexit”).
However, the German Constitutional Court in Karlsruhe may narrow the scope of OMT by attaching more conditions to it. Under OMT, the ECB specified a list of economic reforms it would require of countries as a condition for making loans to them (i.e. buying bonds from them). Those rules could get tougher.
The basis for the 11,000 enraged Teutons’ lawsuit alleging that ECB was breaking the rules of its mandate is that the ECB is specifically prohibited under the European Union’s founding treaty from buying government bonds from eurozone member governments – directly, at any rate.
To get around this irritating limitation, the ECB, under OMT, announced it would buy government bonds only from secondary bond markets – i.e. it would buy the bonds from private institutional investors, such as pension funds or commercial banks, who had previously bought those bonds from the governments that issued them.
The plaintiffs insisted this secondary-market winkle was merely a dodge. The German Constitutional Court agreed – sort of – but chose to withhold a formal judgment, instead referring the lawsuit to the European Court of Justice (ECJ), in the spirit of tossing a very hot potato to someone else. That was in early 2014.
As we’ve noted, the ECJ green-lighted the OMT program in June 2015. But now the ball (or potato) is back in Karlsruhe’s court, because when the scarlet hats referred the case to the ECJ in 2014, they reserved the final judgment over the constitutionality of OMT for themselves. One may wonder whether they’re now regretting having done so. The potato remains very hot.
Another interesting question concerns the 11,000 enraged German plaintiffs. Do they still actually want the Karlsruhe court to rule OMT unconstitutional, an action which could very well precipitate the end of the European monetary union and perhaps the fragmentation of the EU itself?
A typically German response might be: “The rules are the rules. If the rules are being broken, the Court must rule against OMT, regardless of consequences.”
OMT isn’t APP
A point of clarification: Some readers will be aware that the ECB has been buying 60 to 80 billion euros ($67 to $90 billion) worth of bonds each month from secondary bond markets since March 2015, using its ability to flood central bank money, or “reserves,” into the balance sheets of institutional investors – a practice known as “quantitative easing” in finance jargon.
Those purchases aren’t being made under OMT, but rather under a different program called the “expanded asset purchase program” (APP). Under APP, bonds are being bought from nearly all eurozone governments, in proportion to the sizes of their economies, with no strings attached. OMT, by contrast, is restricted to bailing out troubled governments.
A little history
On July 26, 2012, at the height of a sovereign bond crisis affecting southern European countries, European Central Bank president Mario Draghi gave a speech in which he said, “Within our mandate, the ECB is read to do whatever it takes to preserve the euro. And believe me, it will be enough.”
His remarks, delivered at the “Global Investment Conference” in London, were understood to mean that the ECB would buy bonds issued by eurozone member nations in whatever quantities necessary to prevent further unsustainable increases in the interest rates paid to private bond investors by those nations – increases which were widely seen as threatening the solvency of several governments.
The ECB soon gave a specific shape to Draghi’s “whatever it takes” vow. On August 2, 2012, just a week later, the ECB’s Governing Council announced a program called “outright monetary transactions,” or OMT.
With OMT, the ECB claimed the power to buy and sell sovereign bonds (bonds issued by the governments of eurozone member nations) in whatever quantity necessary for “safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy.” OMT’s technical framework was announced later, on September 6, 2012.