Economic News & Analysis—September 12, 2012

German Constitutional Court steps out of the way of ESM

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

The German Constitutional Court announced today that it was dismissing complaints against German ratification of the ESM. On June 29, the Bundesrat and Bundestag (the German upper and lower houses, respectively) had ratified the creation of the permanent bailout fund, the ESM. Shortly thereafter, a small group of anti-euro Germans sought help from the German Constitutional Court to block the final ratification of the treaty by the president of Germany. The basis of the suit argued that the ESM possibly created an unlimited liability for the Germans and undermined the budgetary autonomy of the Bundestag. In a similar suit, anti-euro Germans pressed the court to block ratification of the fiscal pact where eurozone governments agreed to limit budget deficits.

Ultimately, the German Constitutional Court stepped out of the way and declared that ratification of both the ESM and fiscal pact could proceed with the understanding that the liabilities for Germany would be capped at 190 billion euros and changed only with the approval of the Bundestag. In my opinion, this was a pragmatic ruling. The people elect members of the Bundestag, and the Bundestag still has final say on German budgetary matters. If someone doesn’t like what the Bundestag does, well, to paraphrase Chief Justice John Roberts of the U.S. Supreme Court, the Court can’t always protect people from their political decisions. If you don’t like what a politician does, don’t vote for him or her next time.

The next step will be for Italy to ratify the ESM in order for it to become operational, which seems highly likely considering the Italian government could benefit from a precautionary credit line from the ESM. The Italian government may not need actual funds from the ESM, but the European Central Bank (ECB) has outlined a plan to intervene in the secondary debt market to drive down short-term (three years or less) borrowing costs of governments that seek and receive help from the ESM. The Italian government could use some assurances from the ECB that its short-term debt costs won’t spike higher.

The ESM will be phased in over the course of 2013 to replace the temporary bailout fund, the European Financial Stability Facility (EFSF). The ECB’s debt-buying plan, Outright Monetary Transactions, is contingent upon governments abiding by the budget and reform conditions imposed by international lenders, like the EFSF, the ESM, or the International Monetary Fund (IMF). Thus, even if the ESM was blocked or it had inadequate funds, the IMF could still provide additional long-term financing.

I believe the government to watch now is the Spanish government. Leaders in Spain have been hesitant to ask for a bailout until the ECB’s plan was better articulated, which had been complicated by the fact that the ECB’s plan was somewhat dependent on the ratification of the ESM. With a clearer path to ESM ratification now in place, we’ll wait to see if Spain requests assistance. I believe that if Spain decides to seek aid, it would be beneficial for the euro and for eurozone stocks and bonds.

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