Interpreting the Karlsruhe based German Constitutional Court’s February 2014 ruling on the legality of the OMT (“Outright Monetary Transactions”) program requires knowledge of German, Germany’s basic law and (a little) quantum physics. Whatever the interpretation, its potential effect on the evolution of Europe’s debt crisis is being underestimated.
Don’t Know BUT!
Announced in 2012, the OMT would theoretically allow the European Central Bank (“ECB”) to make unlimited purchases of government bonds issued by Euro-Zone members under specified conditions, providing funding and lowering borrowing costs. In conjunction with the austerity plan to reduce budget deficits and public debt and the banking union, the OMT has underpinned the relative stability of European financial markets over the last 18 months.
Prompted by a petition filed by 37,000 Germans, the Constitutional Court reviewed the OMT’s legal status. Following several months of consideration and often heated hearings, the court did not decide the matter, referring it to the European Court of Justice (“ECJ”) in Luxembourg.
The court ruling was by a 6-2 majority. The two dissenters ruled that the suit should be dismissed on the grounds that it was outside the court’s jurisdiction.
The court requested that the ECJ clarify several issues: the legality of the conditions of the OMT, the absence of any limit on purchases, the ECB’s ability to selectively purchase bonds of only some members, the lack of consideration of the credit quality of the bonds, the ability to purchase in the primary market, the need to hold the bonds to maturity and the interaction between the OMT and other ECB and European Union (“EU”) programs.
But the Court also stated that the OMT may be incompatible with German basic law. It found that the program exceeds the ECB’s limited monetary policy mandate, infringes upon member states and also circumvents the prohibition of monetary financing of Euro-Zone members. The Court found that the program was an act of economic policy, beyond the powers of the ECB.
Interestingly, the German court announced that it would rule separately in March 2014 on the European Stability Mechanism (“ESM”), the fund set up to aid distressed Euro-Zone members.
The referral creates an intriguing set of potential outcomes.
If the ECJ agrees with the court that the program is illegal, then the ECB program cannot be implemented.
The ECJ may agree with the German court that it is not legal in its current form, leaving the way open for a compromise left open by Karlsruhe. This would entail a more limited OMT program with a limit on the quantity of bond purchases, protection of the ECB from loss in a debt restructuring, imposition of the same conditions applicable to ESM aid recipients to issuers benefitting from the bond purchases and no interference with market prices where possible.
If the ECJ rules that the OMT is legal in its present form, then the program would theoretically be legal under European but not German law. Should the OMT be utilised, it is not clear if the Bundesbank, the German central bank, could participate.
The way the issue would arise is clear. Potential users of the OMT have to apply for a conditional credit line from the ESM, which requires government approval. If the German government and parliaments approve the credit line, then a legal challenge is likely.
Based on its current position, the constitutional court would have to declare the program illegal under German law. But the constitutional court would then be in violation of EU treaties for not accepting the ECJ ruling. It is unclear whether this would lead to initiation of treaty infringement proceedings against Germany.
This would trigger a legal crisis, preventing Bundesbank participation in the OMT, withdrawing German support for various rescue programs or, theoretically, forcing Germany to exit the Euro and the EU itself.
Defender of the Commons
The decision has a political dimension.
The constitutional court’s decision is predicated on protecting democratic rights, establishing “legal boundaries” to the powers of the ECB mandate and strengthening “the guarantees provided by [the German] constitution“.
It reflects the court’s increasing concern that the German government, parliament and the EU may not protect German citizens from the exposure created by the ECB and various policies to rescue beleaguered Euro-Zone members. It also reflects concern about the abrogation of German voter’s rights on economic and budgetary policy.
The court is also concerned about the secretive process underlying much of this decision making. The court sought information regarding the ECB’s OMT programs but was rebuffed on the ground that details are “classified”.
Complementarity and Uncertainty
Financial markets have generally remained unmoved by the court’s ruling.
In part, this reflects the view that the OMT was never activated and may be no longer needed. It also reflects an exaggerated view of the powers of the ECB. One banker dismissed the court as “the crimson-robed weirdos in Karlsruhe”.
But if the European debt problems re-emerge, then the court’s decision may restrict the ability of the ECB to act.
European politicians, especially those favouring ECB intervention, and non-German central bankers are also frustrated by the constitutional court. They believe the authority for the OMT lies properly with parliament, government or the central banks. With the European Parliament elections due in May 2014, they also fear that the decision will strengthen the political position of Euro sceptics, making future intervention in support of weaker member nations more difficult.
In physics, the Complementarity Principle, suggested in 1928 by Danish physicist Niels Bohr, posits that the behaviour of phenomena, such as light, exhibits both wave and particle properties at the quantum level. Suggested by Bohr’s pupil Werner Heisenberg, the related Uncertainty Principle states that it is impossible to exactly measure simultaneous values of the position and momentum of a physical system. These quantities are calculable with characteristic ‘uncertainty’.
Complementarity and Uncertainty define the ultimate limitations of physical property and actions.
The Court’s decision embraces Complementarity. OMT proponents claim that it supports the ability of the ECB to undertake OMT program. Opponents claim that it actually prevents the ECB from engaging in such purchases. The decision also fits with the Uncertainty principle as its effects are impossible to quantify, other than in a probabilistic manner.
Whatever happens, the debate about the scope of the ECB’s powers, which underpins the Euro and the fate of many deeply indebted European countries, has not been settled. It highlights the unstable confluence of politics, finance and law that lies at the heart of the Euro-Zone crisis.
© 2014 Satyajit Das
Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money