Rome— The euro zone dodged a potentially fatal bullet when Germany constitutional court ruled that the new €500-billion ($644-billion U.S.) bailout fund could go ahead. But it attached conditions on its use that will limit its ability to maneuver.
The ruling came as a relief to the markets, which had been rising steadily since the middle of last week on the expectation that the German court would not lift an injunction against the fund, known as the European Stability Mechanism (ESM). Economists and strategists agreed that a “nein” vote would have triggered market chaos.
Markets rose after the ruling. The euro hit a four-month high $1.29017 (U.S.) and the FTSE-100 index climbed almost half a percentage point.
Setting a cap of on Germany’s ESM liability appeared to be the key condition set by the court’s eight judges. They ruled that the €190-billion in German financial guarantees already approved by the German parliament could only be increased by another parliamentary vote.
In effect, this limits taxpayers’ exposure to a fund that is gearing up for more sovereign rescues.
The ruling no doubt pleased German chancellor Angela Merkel, who had backed the ESM but did not want to expose taxpayers to potentially unlimited liability as she comes up for re-election in 2013.
The preliminary court ruling Wednesday morning came on a crucial day for the 17-country euro zone, which has slipped back into recession and may yet sweep Spain into the sovereign bailout club, joining Greece, Ireland, Portugal and Cyprus.
Later today, the results of the Dutch election, which pits broadly pro-Europe parties against several strong Eurosceptic parties, will be known. A victory by the Eurosceptic parties – an unlikely scenario according to the latest polls – would probably turn a key creditor country into a foe of further euro zone bailouts and integration The German court ruling also came as the European Commission, the European Union’s executive arm, unveiled plans for common banking supervision that would make the European Central Bank the supervisor of the national supervisors. Meanwhile, Greece remained locked in negotiations with the troika – the EU, the ECB and the International Monetary Fund – on another deep round of austerity measures.
The court ruling appeared to strike a fine balance between the courts concerns about protecting German democracy and taxpayers and Germany’s political commitment to a united Europe with a common market and a common currency.
The ESM is designed as the permanent successor to the EFSF – the European Financial Stability Facility – that played a key role, with the IMF at its side, in the bailouts of Ireland and Portugal. The EFSF has only about €150-billion of remaining firepower.
Germany is the single biggest guarantor of the ESM. The fund would not only be charged with sovereign bailouts; it would also buy the long-term bonds of distressed countries in return for strict austerity and economic reform commitments. Once those commitments are reached, the ECB would buy short-term sovereign bonds, making the ESM and the ECB a tandem crisis-fighting team.
The Germany constitutional court had had several grave concerns about the ESM.
“The basic complaint against the ESM is that it would irreversibly delegate national sovereignty to the European level and that it would interfere with the national parliament’s right to adopt the budget,” Carsten Brezeski, economist of ING Financial Markets, said ahead of Wednesday’s ruling. “Moreover, the complaints criticize a so-called democratic deficit, i.e., that ESM decisions could not be controlled by a representative body of the people which is [legitimized] by elections.”
Before the ruling, more than 37,000 German citizens signed a challenge to the ESM. Their fear was that the fund would not be subject to democratic control, making it a potentially rogue funding operation for countries that were the authors of their own financial problems. Their goal was to hold a referendum on the fund