In what was a shocking and disappointing at the same time decision, overnight the German Constitutional court, which had been contemplating the legality of the ECB's still non-existent OMT program, conceived in July 2012 to prevent the collapse of the Eurozone and still only existing in Mario Draghi's head as it has zero legal documentation supporting it, said that, in its judgment, the ECB's Outright Monetary Transactions program likely exceeded the central bank's powers.
"There are important reasons to assume that [the OMT] exceeds the European Central Bank's monetary policy mandate and thus infringes the powers of the member states, and that it violates the prohibition of monetary financing of the budget," the German court said Friday. "Subject to the interpretation by the Court of Justice of the European Union, the Federal Constitutional Court considers the OMT decision incompatible with primary law," the German court said.
At that point it quickly washed its hand of the consequences of having founds the OMT illegal, and referred the final decision on the legality of the European Central Bank's bond-purchase program to the European Court of Justice, and in doing so gave the ECB a panel of judges that is more sympathetic to the OMT and the central bank's ability to conduct monetary policy as it sees fit. It also killed two birds with one stone: allowed Germans to claims internally that the OMT is illegal, while everyone else in Europe gets to pretend that the continent is solvent, and that the ECB can backstop sovereign bond purchases with an imaginary contraption that contrary to mass delusion, simply does not exist and would fall apart the second it is used for the first time.
The WSJ reports:
The European Court of Justice has traditionally sided with European Union institutions on their interpretation of EU law.
"The announcement should clearly reduce the Karlsruhe fear factor for the ECB," said Carsten Brzeski, an economist at ING Bank, referring to the city that is home to Germany's top court.
Friday's announcement "could either be a sign that the court has reached its legal limits on European issues or that the issue is so tricky and touchy that it is better to pass it on," Mr. Brzeski said.
The OMT is widely seen as a success. Spanish and Italian bond yields fell sharply after Mr. Draghi's July 2012 speech and subsequent creation of the OMT, and have remained low since. The pledge to buy bonds was so successful in shoring up investor confidence in the euro's future that the OMT has yet to be used.
But the program, which was vehemently opposed by Germany's central bank, raised concerns in Germany that the ECB was blurring the line between fiscal and monetary policy and making it easier for governments to backtrack on their commitments to reduce debt.
"The ECB reiterates that the OMT program falls within its mandate," the ECB said in a statement after the German court's announcement.
But German judges had a different view.
It remains to be seen if the Germans react to this decision in any way, although at this point it is safe to assume that things in Europe will continue on their unmerry path until finally one of the unintended consequences of the monetary union - such as completely social collapse and record poverty and unemployment - force one of the member nations to revolt on its own and finally bring the entire artificial construct crashing down.
For those who wish to learn more, here is Open Europe's flash analysis of the Constitutional Court's decision:
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New Open Europe flash analysis: I’m the German Constitutional Court, get me out of here! Court sees ECB bond buying as illegal but refers questions to ECJ
Summary: The German Constitutional Court (GCC) – Bundesverfassungsgericht – has referred several questions surrounding the ECB’s Outright Monetary Transactions (OMT) programme to the European Court of Justice (ECJ). It is evident that the Court believes the OMT is illegal and incompatible with EU and, therefore, German law. However, the Court only has jurisdiction to rule on matters of German domestic law. It therefore argues that it must refer the key questions to the ECJ – the body which interprets EU law – given that the ECB’s mandate and any overstepping of EU treaties is obviously a question about EU law.
The ECJ is likely to side with the EU institutions and rule that the OMT is compatible with EU law, with the GCC likely to therefore say its hands are tied. Still, the decision throws new uncertainty into the fragile eurozone economy and could hamper the recovery. The GCC may also, in its interpretation of the OMT’s compatibility with German law, insist in new red lines - potentially limiting the level of purchases. This itself would severely restrict the role of the ECB.
What are the new developments?
Surprising news out of Karlsruhe this morning as the GCC has asked the ECJ to rule on whether the ECB’s OMT programme – a promise by the ECB to buy an unlimited number of government bonds if the eurozone crisis worsened – is “compatible with the primary law of the European Union”. The legality of the OMT is a hugely important issue given that it is widely seen as a key factor in stabilising the eurozone and preventing a break-up.
The Court stresses that it believes the programme does violate the law, but can be brought in line with the treaties.
“The subject of the questions referred for a preliminary ruling is in particular whether the OMT Decision is compatible with the primary law of the European Union. In the view of the Senate, there are important reasons to assume that it exceeds the European Central Bank’s monetary policy mandate and thus infringes the powers of the Member States, and that it violates the prohibition of monetary financing of the budget. While the Senate is thus inclined to regard the OMT Decision as an ultra vires act, it also considers it possible that if the OMT Decision were interpreted restrictively in the light of the Treaties, conformity with primary law could be achieved.”[]
What questions have been referred to the ECJ?
The GCC only has competence over German law and cannot make judgements surrounding EU law. Clearly from the above, the GCC believes that the OMT violates the mandate of the Bundesbank and the ECB. However, to conclusively prove so, it requires the ECJ to make a judgement on the OMT as well. The first key question it asks is:
Is the OMT “to be qualified as an independent act of economic policy?”
The GCC believes that it is and that it therefore goes beyond the mandate of the ECB, which only refers to monetary policy. It also stresses that the OMT could lead to “considerable redistribution between the Member States”, which is forbidden by the treaties. The GCC also asks the ECJ to rule whether:
The OMT programme “violates the prohibition of monetary financing of the budget (Art. 123 TFEU)”.
Again, here it seems the GCC believes that it may well do, and that if it were decided so, the GCC would have to stop the German authorities from taking part. Essentially, the GCC has asked the ECJ to rule whether the OMT is fundamentally compatible with the primary law of the EU.
Will the GCC still provide its own ruling?
Yes, but likely only after the ECJ has ruled. The GCC seems to be stuck. It has serious concerns over the OMT and its compatibility with the EU treaties and German law. However, it feels it cannot rule on issues of German law until the questions over EU law have been settled – which are outside of its jurisdiction. Once the ECJ has ruled, the GCC will likely re-examine how the OMT fits with German law, however, it will be constrained by the ECJ’s ruling and interpretation of EU law.
How might the GCC and ECJ rule?
It is patently obvious that the GCC believes that the OMT does violate primary EU law, because it goes beyond the mandate of the ECB and breaks the EU Treaties, and therefore violates German law.
“The OMT Decision does not appear to be covered by the mandate of the European Central Bank.”
“The existence of an ultra vires act as understood above creates an obligation of German authorities to refrain from implementing it and a duty to challenge it. These duties can be enforced before the Constitutional Court at least insofar as they refer to constitutional organs.”
However, given that the GCC cannot rule on EU law it has referred this decision to the ECJ. That said, as the quote below shows, it could still be forced to accept that the OMT is legal if the ECJ approves it and/or there are further restrictions put on it.
“Subject to the interpretation by the Court of Justice of the European Union, the Federal Constitutional Court considers the OMT Decision incompatible with primary law; another assessment could, however, be warranted if the OMT Decision could be interpreted in conformity with primary law.”
“In the view of the Federal Constitutional Court, the OMT Decision might not be objectionable if it could be interpreted or limited in its validity in conformity with primary law in such a way that it would not undermine the conditionality of the assistance programmes of the EFSF and the ESM, and would indeed only be of a supportive nature with regard to the economic policies in the Union. In light of Art. 123 TFEU, this would probably require that the acceptance of a debt cut must be excluded, that government bonds of selected Member States are not purchased up to unlimited amounts, and that interferences with price formation on the market are to be avoided where possible.”
Importantly, the GCC flags up that it could be willing to accept the OMT if it is no longer seen as being “unlimited” and if it is no longer seen as its own economic policy – but as long as it continues to have conditionality. This would require a significant reworking of the OMT and would severely hamper the ECB’s approach to tackling the crisis. It may also provide new boundaries (both legal and practical) on what the ECB can do in a crisis.
Ultimately, then the GCC ruling will depend heavily on how the ECJ rules. That being said, it seems very unlikely that the ECJ would rule against something as significant as the OMT, which has played a huge role in securing the eurozone.
Does this mean the OMT is now invalid?
It certainly casts significant doubt on the issue, however, it remains somewhat in limbo for the time being. The GCC evidently believes that it is illegal and should be invalid or at the very least amended. However, it also cannot provide such a categorical ruling before the ECJ has had a chance to rule or before the OMT has been amended and clarified.
Given that the ECJ tends to rule in line with EU policy and with EU institutions it seems highly doubtful that it would rule against the OMT. If it were to support OMT without any changes, this would put the GCC in a very difficult position. It would be stuck between believing it falls outside the mandate of the German institutions as to their responsibilities to the EU, however, it would not have any clear basis in terms of EU law.
In the meantime, it is clear the ECB still considers the OMT practically operational. In its response to the referral the central bank stated that, “The ECB reiterates that the OMT programme falls within its mandate.”[]
What does this mean for eurozone?
This could well spark further jitters in the eurozone. For all the talk or institutional and structural change as well as national governments pushing reform, the OMT has been the key factor in easing the crisis. It certainly throws a new bout of uncertainty into the very fragile economic recovery in the eurozone. It could drive flows back to where they were previously, with the core countries benefitting from safe haven flows and the periphery being hit by the uncertainty. That said, it is likely that most investors will take a wait and see approach given the number of moving parts in this decision.