The eurozone is running out of bailout cash, and the German Constitutional Court now holds the fate of Europe in its hands.
The European Financial Stability Facility, the original euro area bailout fund established in the summer of 2010, is down to about €248 billion of lending capacity left after existing bailouts for Greece, Portugal, and Ireland are accounted for.
Spain and Italy – the next two countries expected to be in line for a bailout – could have combined financing needs as large as €703bn over the next two years, according to Citi estimates, dwarfing the existing capacity of the EFSF.
Those huge numbers underscore the need for the additional firepower of the European Stability Mechanism, the new bailout fund expected to replace the EFSF and make available hundreds of billions of euros in additional lending capacity to struggling member states.
However, the ESM has still yet to be ratified, which has many counting chickens before the eggs have hatched, so to speak.
The 16 judges that sit on the Federal Constitutional Court of Germany need to sign off on the fund's constitutionality in order to make the fund operational – and the Court is widely expected to do just that when they deliver a ruling on ESM ratification on September 12.
Here are some views from Wall Street:
- "The Court will not rule against the ESM allowing it to become operational, but any conditions could have implications on further integration and debate in Germany." – SocGen economist Anatoli Annenkov, August 24
- "However, the court may also require additional information, particularly on the ECB’s bond purchase plans under existing ESM programmes, before making a final ruling." Citi economist Jürgen Michels, August 23
- "Needless to say, a surprising rejection (not our assumption) would hurt risk sentiment massively." – SocGen fixed income strategist Vincent Chaigneau, August 23
- "There is a chance that things could go wrong and if they do they might go terribly wrong. Hence, caution is warranted." – Morgan Stanley FX strategist Hans Redeker, August 16
- "Our central scenario is a positive ruling from the German court, but there is a slight chance that the ruling makes the ESM implementation delayed or more complex." – BofA Merrill Lynch economist Laurence Boone, August 10
So, even though the Court is widely expected to approve ESM ratification – and the German Bundestag parliamentary body already approved it by a 3/4 majority – what is behind murmurs of caution among analysts and investors?
The constitutionality of the ESM treaty – which is what the Court is set to rule on – is a matter of question in Germany. Several complaints regarding constitutionality have already been lodged against the ESM to the Court.
Philine Schuseil at the European think tank Bruegel has penned a good breakdown of the debate over the ESM in Germany. The upshot is that the ESM, governed by eurozone finance ministers, would have full control over disbursement of ESM funds to struggling countries, even though such decisions would affect the German government budget.
More from Schuseil (emphasis added):
Decisions of the ESM Board could only be democratically legitimated if they would need the approval of national parliaments. The German law accompanying the ESM treaty, the “ESM-Finanzierungsgesetz”, aims at ensuring the democratic basis by obliging German members of the Board to refuse decisions with impact on the German budget and that have not been accredited by the Bundestag. However, according to Professor Dietrich Murswiek , this is legally not enforceable.
So, even though German chancellor Angela Merkel and German ECB board members like Jörg Asmussen have been trying to sell the ECB/EFSF/ESM bailouts to the German electorate as they appear to increasingly realize the massive risks Germany faces if it doesn't hold the euro together, there is still a lot of concern in Germany over the ESM.
A troubling scenario for investors would be a referendum in Germany to reconcile current German law with the provisions of the new ESM treaty, which Schuseil discusses in detail at Bruegel. A recent Pew survey revealed that Germany is deeply split over providing bailout aid to other eurozone member nations, with 48 percent responding that Germany should not be providing financial assistance to other countries.
And even though the Bundestag approved ESM ratification by 3/4 of the vote, there is evidence of increasing bailout fatigue among parliamentary politicians as well:
Back to September 12, though, when the Court is set to rule...
Deutsche Bank economists Stefan Schneider, Barbara Böttcher, Nicolaus Heinen, and Heiko Peters suggest that the drama surrounding the Court's ESM decision is typical and to be expected.
In a recent note to clients, they explained that "almost every parliamentary ratification of major European decisions has been accompanied by constitutional complaints in Germany. They have become a well-known element of German Euro politics during the past two decades. The judgments have often strengthened the role of the German legislature."
The economists conclude by looking beyond September 12 to the future of the debate in Germany:
Germany’s Constitutional Court is increasingly becoming a forum for Euro-skeptic voices to articulate their arguments from a constitutional point of view. These will likely not be the last constitutional complaints on EMU politics in Germany...It remains to be seen whether the Court will remain as constructive as in its previous judgments, weighing democratic legitimacy carefully against considerations of systemic stability and capacities of other constitutional bodies.
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