The FT’s Wolfgang Munchau takes a closer look at last week’s German Constitutional Court ruling on the Greek rescue package. The full article can be found here (may need subscription).
The whole thing is well worth a read, but one of Munchau’s most important points is that while the ESM (the permanent successor to the current bailout fund, the EFSF) may or may not eventually get the court’s approval, eurobonds will not. Given that Munchau has supported Eurozone eurobonds as a possible way out of the current mess, his is a telling interpretation).
Munchau writes as follows (my emphasis added):
[Y]ou cannot get around this unfortunate fact with an ingenious combination of eurocratic trickery and financial engineering. The court, quite cleverly, did not mention eurobonds. It talked about liabilities. The Bundestag is not precluded from giving money to Greece, but it cannot empower a third party, such as the EFSF or ESM, let alone a hypothetical European Debt Agency, from usurping sovereign power. Sovereignty can be delegated in small slices, but not permanently.
A eurobond is, of course, a permanent mechanism. It also involves a permanent loss of control. Its size is very likely to be substantial. There would not be any point in issuing a small eurobond – it would not resolve the crisis. And unless member states were to transfer some of their sovereignty to Brussels, all the inherent risks in the structure would come from non-compliance by national governments or parliaments. In other words, a eurobond perfectly matches the conditions set by the constitutional court for an arrangement that violates the German constitution.
What if the EU decided to create a fiscal union after all? [Germany's] constitutional court already decided in its ruling on the Lisbon Treaty that this is not possible either. A fiscal union would require a referendum, in which the German electorate would decide to abolish the sovereign German state, and transfer sovereignty from Berlin to Brussels. Suffice to say, that this is not very likely to happen. So we have an impasse. No matter how you organise a future fiscal space in the eurozone, it will either be meaningless, or infringe the German constitution.
And what could this mean?
The ruling significantly increases the probability of default by one or several member states. This is a simple consequence of the Law of Large Numbers. There are now so many hurdles in place that a systemic accident is very likely to happen at some point. Do we really think the Bundestag, after having reluctantly accepted the need for a second Greek loan programme, will vote for a third? Or a second Portuguese or second Irish programme? Will they vote Yes once the EFSF starts buying bonds, or recapitalising banks? It takes a single No vote to trigger a default.
The fact that those hurdles ought to be some way in the future brings little comfort. I suspect that they matter now because the real dangers that they present may shift the risk/reward calculations undoubtedly now going on in Germany over the cost to the Bundesrepublik of a Greek default. If the odds are that default or defaults are coming, and if buying time is only spreading the contagion, might it make sense to cut the Gordian debt now?
It’s perhaps worth adding that the court’s judgment is a powerful reminder to investors that there is currently no obvious plan B if the prospect of the enhanced EFSF (plus the current bond buying by the European Central Bank, which, incidentally, seems to be generating diminishing returns) does not calm markets. And that will be cause for further alarm.