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OMT Facing The Judges

By BNP Paribas (Philippe d'Arvisenet)Market OverviewJun 14, 2013 03:03AM ET
www.investing.com/analysis/omt-facing-the-judges-171515
OMT Facing The Judges
By BNP Paribas (Philippe d'Arvisenet)   |  Jun 14, 2013 03:03AM ET
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In Germany, the Constitutional Court in Karlsruhe held public hearings on June 11 and 12 in connection with the case it has been examining for many months against the European Stability Mechanism (ESM), and the ECB’s Outright Monetary Transactions (OMT) bond-buying programme. When called upon to hand down an urgent ruling, the Court issued a preliminary judgment on September 12, 2012. It validated the broad lines of the mechanism’s existence and workings, thereby authorizing ratification in Germany of the Treaty instituting the European Stability Mechanism. Basically, the Court warned that German taxpayers’ financial commitment to the mechanism could not in any circumstances be increased beyond its current size (EUR 190 billion) without a vote in Parliament.

Interest in the Karlsruhe court’s final ruling, which is unlikely to come before the end of the summer at the earliest, was rekindled when the complaints were supplemented by action against OMT, the creation of which was announced in August 2012 by Mario Draghi. The Court must now evaluate whether the program falls within the ECB’s mandate or whether it breaches the ban on providing funding to governments and represents an undue commitment for German taxpayers (via any losses that the ECB may incur on these purchases). If this were the case, the Karlsruhe judges may, for example, ask the German government to renegotiate the treaties to define the ECB’s mandate and scope of action more precisely or oblige it to seek the scrapping of the OMT programme by appealing to the European Court of Justice, which has jurisdiction in matters related to the ECB.

Coverage of this week’s hearings had even increased, since they saw several leading German figures oppose each other, two of whom sit together on the ECB’s Governing Council. Jens Weidmann, President of the Bundesbank, has never made any secret of his opposition to the program. He explained to the judges that OMT weakens the incentive for countries to reform, and that the ECB’s foray into the field of fiscal policy undermined its independence. He stated that he would be in favour of such a programme being explicitly excluded from the central bank’s scope of action. His colleague Jörg Asmussen, a member of the ECB’s Executive Board, expressed the view that this programme falls within the scope of the institution’s mandate since it contributes to the financial stability of EMU and currently helps to avert a deflationary spiral. He also emphasised that renegotiation of articles of the treaties relative to the ECB would be akin to opening up Pandora’s box, insofar as not all governments place as much importance as Germany on the ban on monetary financing of public deficits and as certain countries may seek to redefine its mandate (for example, extending the mandate to pursuing a growth target). Lastly, Wolfgang Schäuble warned about the risks that would arise for the central bank’s independence if Constitutional bodies in each member state started to rule on the ECB. He also indicated that to date the government has not seen any signs suggesting that the ECB’s actions had harmed its mandate.

Aside from the legal considerations, the German government’s support for OMT does not seem surprising. Firstly, it is clear that the respite offered by this programme has enabled minister of finance Wolfgang Schäuble to spend a great deal of his time and energy for almost the past year watering down the promises made in the summer of 2012. The creation of a full banking union was delayed, as well as the prospect of direct bank recapitalisation by the European Stability Mechanism.

Secondly, the OMT architecture allows the ECB to have some implicit backing of European governments. Indeed, a country in difficulty must first be the beneficiary of a European assistance programme before it becomes eligible for OMT1. No support can be provided by the ESM without a vote being passed by its Board of Governors, which consists of the euro zone finance ministers. Given its share of the ESM’s capital, the German finance minister holds a veto on the board. In addition, the finance minister is unable to take action without the backing of a vote in favour in the Bundestag, as the Karlsruhe ensured in a previous judgment. All in all, the German authorities certainly appear to exert some degree of control over the programme. However, it is true that they do not have the means to cap the relevant amounts from the outset, as they have done by setting their stake in the capital of the European Stability Mechanism. Indeed, the OMT programme’s effectiveness depends on the fact that the purchases made will be as substantial as necessary to achieve the ECB’s goal and are thus potentially unlimited2.

Even so, we are a long way from unlimited purchases. While the programme has never been activated and not a single bond has been bought, (10-year) Italian and Spanish sovereign spreads are now well below the levels they were one year ago. Likewise, the German Target2 surplus, considered by many as reflecting a risk to the German public finances, has fallen by more than EUR 160 billion from its August 2012 high. The President of the Karlsruhe Court has stated that this success is not a criterion to assess the programme’s constitutionality; otherwise, this would imply that “the end justifies the means”. That is certainly true but this success is a proof that OMT reduces the risks taken by German taxpayers rather than increases. Old risks actually taken close to 15 years ago, when an incomplete Economic and Monetary Union was put in place.

BY Frédérique CERISIER
OMT Facing The Judges
 

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OMT Facing The Judges

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