Europe Showdown: Will Germany Affirm ECB’s Super-Solution?

Wall St. Cheat Sheet

The Federal Constitutional Court is set to review the legality of a bond purchasing program run by the European Central Bank this week. The move will result in a showdown between the German central bank, Bundesbank, and the ECB, as Bundesbank President Jens Weidmann is expected to testify against the Outright Monetary Transactions program he voted against in the past.

The OMT allowed the ECB ‘unlimited’ access to buy short-term government bonds from countries signed up help under the European Stability Mechanism―a program also under review this week―as well as the European Financial Stability Facility.

The German plaintiffs are concerned about liability issues, as well as constitutional issues, arguing that the programs both exceed the ECB’s mandate and expose German taxpayers to large amounts of risk. The plaintiffs involved are a opposition political party in Germany, and a lawmaker from the Bavarian counterpart to Angela Merkel’s own Christian Democratic Union.

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Specifically, the plaintiffs allege that the risks created for Germany by the ECB are outside the ability of German lawmakers to protect themselves from. They hold that the German parliament still has control over the country’s exposure to financial liabilities, even in the case of rescuing other European countries. Moreover, they argue that the ECB has violated the powers it possesses under European law, most notably the laws which ban government financing by the central bank.

However, the ECB has prepared to defend itself, and sees its bond-buying program as a legitimate means to execute its primary goal of price stability. Since investors are placated enough to invest in foreign bonds because of the OMT, supporters argue that the market confidence created is responsible for price stability throughout the EU. ECB President Mario Draghi has vehemently defended his bank’s decision to maintain the OMT as a tool for stability. Speaking last week, Draghi described it as, “probably the most successful monetary policy measure undertaken in recent times,” adding that, “OMT has brought stability not only to the markets in Europe, but also to the markets world-wide.”

The OMT, though, has never been used to date, only offered as a possible support option for future troubled countries. As economic reforms are an ongoing process in Europe, and the battle over austerity and stimulus continues, the conditions in which investors are buying bonds remain dubious. If markets continue buying up bonds from cash-strapped countries such as Spain, and these countries don’t generate the growth needed to collect tax revenue and pay the interest on bonds, the possibility of failure and future bailouts will remain real, something Germany is looking to avoid.

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The situation is somewhat awkward for Angela Merkel, who supported the OMT despite the Bundesbank opposition. While technically the German court cannot force the ECB to cancel the OMT, it can decide that the program is incompatible with the German constitution, forcing Merkel into a rather tumultuous political situation.

However, legal experts expect the court to decide oppositely, while questioning the merit of the program. Christoph Ohler, a law professor at Jena University, predicts that, “It’s tough to say exactly how the court will handle this, but we can expect something close to the ’yes, but’ approach the judges have used before in European integration and euro-rescue operation cases. The court has never blocked anything on the European level, but in the ’strings-attached’ part unusual and surprising details can always pop up.”

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