My semester as Daimler Fellow at the American Academy in Berlin is coming to a close, and I want to thank the AAB for a fantastic experience. With my return to the US in the offing, I’d also like to offer some final thoughts on a few issues I’ve been discussing with colleagues over the last several months, on this blog or elsewhere. I first want to reflect a bit further on the constitutional dimensions of the Eurozone crisis in Germany. A later post will offer some reflections on the ‘power of the European idea’, not merely in relation to the Eurozone crisis but also to my own scholarship on the EU.
In a week in which the European Central Bank (ECB) announces that it is cutting off liquidity to certain Greek banks while the head of the ECB talks openly of a possible Greek exit from the Euro, it might seem a bit beside the point to continue dwelling on the public-law/constitutional dimensions of the Eurozone crisis, in Germany or elsewhere. If the Euro dies, it will almost certainly be for economic and political, and not specifically legal and constitutional, reasons.
Nevertheless, if there is an ultimate coup de grâce for the Euro, constitutional adjudication—and more particularly German constitutional adjudication—may help to provide it. I am not necessarily predicting a frontal challenge to the EMU, however. The power of the European ideal remains strong, even (or especially) in Germany, and the German Federal Constitutional Court (GFCC) is no doubt sensitive to that reality, as it negotiates between the demands of the crisis and the desire to preserve the integrity of German democracy. As Martin Wolf argued in the pages of the Financial Times a few weeks back, pro-European idealism serves as one of the major centripetal forces keeping the otherwise disintegrating Euro together, particularly in the eyes of European elites (more on that in a later post).
Nevertheless, even if the GFCC does not want to take on the role of executioner of the common currency (after a verdict handed down in the ‘court of economic and political realities’, so to speak), its jurisprudence will almost certainly help to shape the mindset of German decision makers as they seek to resolve the crisis going forward. And as we know, the decisions made by German leaders, for good or ill, have been decisive in this crisis.
The impact of the Court on German policy making is already evident, for example, with regard to the European Stability Mechanism (ESM). Worried about the inadequate legal basis for the ESM in the existing EU treaties—and hence a possible adverse judgment from the GFCC on its legality—the German government insists on a treaty change to provide the needed foundation. The member states have opted for the simplified revision procedure under the Treaty of Lisbon to effectuate this change, even though the ESM itself will be established through a separate international treaty. (Incidentally, this puts the Cameron government in an ironic position: Even though the UK will not take part in the ESM and has also opted out of the Fiscal Pact, it recently pledged in the Queen’s Speech to ratify the ESM-driven revisions to the EU treaties, which creates some potential for political interference by Tory backbenchers if they choose to mobilize—for an explanation, see here).
The shadow of the GFCC is also being felt elsewhere in German politics. Most importantly, the Court has played a major role in forcing an increased involvement of the Bundestag in overseeing Germany’s participation in the Eurozone bailouts, something I’ve discussed previously on this blog (here and here). Moreover, the German government’s well-known resistance to Eurobonds is not just political; as outlined here, it also almost certainly reflects concerns over how the Court would react. (An intriguing alternative to Eurobonds, and a possible workaround of the GFCC’s democratic concerns, might be so-called ‘Euro-coupons’, but I’ll need to explore that in a later post.)
The democratic concerns of the GFCC, manifest in its attitudes toward Bundestag oversight and Eurobonds, arguably suggest a broader question: whether the Demokratieprinzip under German constitutional law, which seems to be looming ever larger in the Court’s recent Eurozone jurisprudence, might eventually serve as a basis for a more broad-based attack on Germany’s participation in the EMU itself. This question, for example, was at the heart of my previous post about the implications of the so-called Target2 imbalances in Germany. Target2 imbalances are interesting in this regard because they arise from a technical-legal feature of the EMU itself and give rise to legal obligations that in some sense go to the essence of the system. A legal challenge to them would strike at the very foundations of the EMU.
For reasons suggested here and here, however, I now think an argument based on the Target2 imbalances alone may be a constitutional non-starter. My initial post on Target2 was apparently based on a mistaken assumption: that the imbalances create a material risk of loss in the event of a member state exit from the Euro, which would then give rise to a specifically legal obligation to recapitalize the Bundesbank (actually, the ECB, perhaps via the Bundesbank). The potential for these losses would, in turn, create a legal incentive structure that effectively compelled German politicians into bailouts or other measures contrary to both the no-bailout clause in the treaty and the limited democratic legitimation originally given to the creation of the EMU (i.e., monetary union, not political union). If this assumption were true, my prior post argued, then the incentive structure at the heart of the EMU’s payment system would place a ‘“sword of Damocles” over German politicians and taxpayers, trapping them in a web of unforeseen legal and political obligation to rescue other Eurozone members, lest Germany face, in the extreme, potentially massive Target2 liabilities’.
But as I have since learned (although I have to admit that I’m not entirely convinced of this yet), these Target2 liabilities may be unlikely to materialize in the manner I thought. The reason relates to a peculiar feature of central banks: Generally speaking, they can’t go broke, and thus the legal obligation to recapitalize Bundesbank (or again, really the ECB) because of Target2 losses is not really a material risk in the current crisis. With the purported Target2 risks seemingly out of the way, all we are left with are the already well-known economic and political risks—a devastating financial crisis—that would arise from the possibility of a member state exit or worse (an EMU collapse), which may well dwarf potential Target2 liabilities in any case. The consequences of these risks, if realized, would undoubtedly be serious and even catastrophic. Nevertheless, the incentives to avoid them, unlike the incentives in the Target2 theory I was positing, seem to be essentially non-legal in character, or perhaps insufficiently legal to trigger the sort of review my last post was contemplating.
Consequently, I now question whether the Court would see the evidently horrible incentive structure inherent in the crisis-racked EMU as violating the GFCC’s judgment of September of last year. In that case (notably para.125), the Court stated that the Bundestag may not ‘subject itself [sich ausliefern] to any mechanism of financial effect, which—whether on the basis of its overall conception or an overall assessment of its individual measures—could lead to unclear burdens of budgetary significance, be they expenditures or revenue losses, without prior constitutive consent’ of the Bundestag itself. Of course, the overall structure of incentives in the EMU beyond Target2 (financial, economic, and political) could perhaps fit comfortably within the meaning of this language. Nevertheless, I very much doubt the Court would apply this principle to question the constitutionality of the EMU as a whole (although it might be justified in doing so). Rather, as I suggested in my Target2 post, this language may ‘amount to a sort of surenchère verbale from which the court will inevitably have to retreat in the face of the fait accompli of monetary union as well as the functional demands of resolving the Eurozone crisis’.
But beyond Target2, there remain serious democratic concerns regarding the actions of the European Central Bank in this crisis that could eventually come before the Court. Whether the Court actually takes up these questions is a matter of jurisdiction and standing that are clearly beyond my expertise as a legal outsider in Germany. Moreover, the Court might also exercise its usual judicial deference to executive and technocratic decision makers on matters of economic and financial complexity (although, as I pointed out here, the Court may now have reason to scale back the usual ‘margin of appreciation’ as to the EMU).
As to the substance of a possible claim, my prior post on Target2 imbalances alluded to some of the broader concerns via the quotation from the op-ed of Jens Weidmann, President of the Bundesbank: ‘Decisions relating to the redistribution of major solvency risks of banks or governments among taxpayers across the euro area is [or should be, contra the practice of the ECB] the sole responsibility of elected governments and parliaments’. Leading economists outside the Bundesbank have long echoed these concerns. For example, the noted economist Willem Buiter, in an article co-authored in August 2011 with Ebrahim Rahbari and Juergen Michels for the Centre for Economic Policy Research, argued that just because Target2 imbalances are not in themselves problematic, they still may be ‘suggestive of serious problems’ within the Eurosystem as a whole. Buiter and his co-authors elaborated:
In particular, these imbalances may be – and currently likely are – a symptom of the difficulty of banking systems in a number of Eurozone periphery countries have in funding themselves in the markets without public support. . . .
The reliance of the Eurozone periphery banking systems on central bank funding also raises potential questions about the terms and appropriateness of the funding provided by the [national central banks (NCBs)] and the Eurosystem. In particular, it is plausible that much of this funding is associated with quasi-fiscal subsidies. To some extent these quasi-fiscal subsidies may be unavoidable in periods of acute crisis if explicitly fiscal support facilities are either too slow or too small to respond properly. More likely, the explicitly fiscal support facilities like the Greek Loan Facility, the EFSF, and the EFSM [or, frankly, the future ESM] have been kept small deliberately by politicians in order to force the ECB into the position of being the only agency capable of preventing multiple disorderly sovereign defaults, some of them probably fundamentally unwarranted, and the inevitably associated banking crisis and wider financial crisis. The result is an ECB/Eurosystem heavily exposed to sovereign credit risk, through its outright holdings under the [Securities Market Program (SMP)] of €74bn worth of debt issued by sovereigns that are likely to default and its much larger exposure through collateral issued by or guaranteed by sovereigns that are likely to default, for loans to institutions that are themselves likely to fail should the sovereign default.
From a democratic legitimacy standpoint, the key passage is the following (with emphasis added by me):
Even though both the exposure of the explicitly fiscal Eurozone and EU facilities and the exposure of the quasi-fiscal ECB/Eurosystem involve tax payers’ money, the former do so transparently and the latter opaquely. This outcome may well be desired by policymakers wishing to hide the true scale of the problems in the banking sector and keen to reduce the need for the public purse to be opened in a transparent way. They do, however, highlight a huge lack of transparency that exists as regards the terms and conditions of portfolio investment and lending decisions of the ECB, including composition of its outright holdings of securities and of the collateral it holds, the prices at which it buys and sells securities held outright, the valuation of collateral, and the models used to price illiquid securities. This lack of transparency is further aggravated by a lack of consistency and diminished credibility created by the ECB’s waiver of the minimum rating thresholds for the sovereign debt for Greece, Ireland, and Portugal, and the lack of clarity about the rules governing the operation of [emergence liquidity assistance mechanisms (ELAs) to their banks]. These are real and substantial issues that merit thoughtful discussion.
What is the proper forum for the ‘thoughtful discussion’ of these ‘real and substantial issues’? Jens Weidmann, as President of the Bundesbank, was (to his credit) suggesting that the ECB and the Eurosystem may have breached the limits of its technocratic legitimacy and stepped into a domain of democratic decision making, in which ‘elected governments and parliaments’ must make the crucial decisions.
The actions of the ECB under the recent Longer-Term Refinancing Operations (LTRO) seem to raise similar or even greater democratic concerns. Under the two rounds of LTRO at the end of 2011 and beginning of 2012, the ECB pumped over a trillion Euros into the European banking system under three-year low interest rate loans. Most of the LTRO loans were likely taken up by banks in the European periphery as a consequence of their inability to get funding elsewhere (something also driving Target2 imbalances). Additional liquidity has also been channeled through NCBs via so-called Emrgency Liquidity Assistance (ELA). This all raises the prospect, as Willem Buiter and Ebrahim Rahbari outlined in a more recent piece, that:
pouring liquidity on demand into the banking system, at deeply subsidized rates and against potentially very poor collateral keeps the banks alive but reduces the banks’ incentives to clean up their balance sheets, recapitalize, restructure and consolidate. We are at risk of importing into the euro area an undesirable feature of the early post-Soviet Union collapse Russian state-owned banking system – where the banks were insolvent but highly liquid. Weaning the addicted zombie banks off cheap central bank liquidity will not be a simple task.
Buiter and Rahbari continued: ‘We hope and expect that the ECB/Eurosystem will manage these challenges and address these risks effectively during the years to come’.
Well, we all hope and expect this as well, but how will we know? Certainly the actions taken by the ECB this week with regard to possibly insolvent (and likely Greek) banks are encouraging, if opaque. As one close observer of the ECB, British economist Anne Sibert, wrote in 2010:
The Eurosystem is subject to little substantive accountability. It is clear that no one, not the European Parliament, nor the Council of Ministers, nor the European Commission can impose sanctions on the Eurosystem. Members of the Executive Board serve eight-year, non-renewable terms; national central bank governors serve at least 5-year terms. Their compensation is internally decided. Governors of national central banks and members of the Executive Board can be fired only in the event of incapacity or serious misconduct. Mere gross incompetence is not a firing offence. The only checks are the fear of shame and embarrassment, the threat of being reviled by the press and reputational concerns. While the independence associated with a lack of substantive accountability may be attractive for the ECB as monetary policymaker – it shields policymakers from politicians who might want to use monetary policy opportunistically – it is far less desirable for the Eurosystem in its financial stability role.
With little substantive accountability, formal accountability is imperative for legitimacy. When the Eurosystem engages in lending activities, it must value the collateral that it is offered, decide whether to accept or not, and to impose a proper liquidity “haircut” or discount on this valuation. If the collateral is valued properly and the right haircut is imposed, then the risk-adjusted expected return to the Eurosystem on its lending will equal the market risk-free rate: there will be no ex ante subsidy or tax. But, if the ECB is not sufficiently aggressive with its valuations and haircuts [as it may well have been in the previous LTROs], then it is transferring wealth to the borrower: a political act that could threaten its legitimacy.
In a more detailed treatment of the same question, Sibert added:
It is telling that while the Federal Reserve Board Chairman testifies before the US Congress, the President of the ECB has [merely] a quarterly dialogue with the European Parliament. . . . For there to be formal accountability, the ECB must be transparent: that is, it must inform the citizenry of its actions and decisions and justify them. Unfortunately, the ECB – notoriously opaque in its conduct of monetary policy – is demonstrating perhaps even less transparency in its financial stability role.
Given the realities of the current crisis, which have given vastly greater importance to the ECB’s financial stability role, this area would seem ripe for heightened political (and particularly parliamentary) oversight. Indeed, one could imagine, based on the GFCC’s decisions on Bundestag involvement in the Greek bailout in September 2011 (here) and the EFSF in February 2012 (here), that the Court might see this heightened oversight as a constitutional imperative, should the question ever come before the Court.
A decision along these lines, however, would require the Court to revisit its notoriously complacent handling of the independence of the ECB in its Maastricht Decision of 1993 (see paras.95-96). And given the role of the European Parliament (EP) in this area as well, it would also force the Court to revisit the adequacy of the system of ‘dual legitimation’ in the EU, via both the national parliaments and the EP. Given the Court’s apparent skepticism of the EP as an instrument of genuine democratic legitimation, at least as evidenced in the Lisbon Decision of 2009 (see paras.274-95)—not to mention the financial stakes for the German taxpayer and German democracy in this crisis—it would hardly be surprising if the Court were to privilege Bundestag over EP supervision in this domain, again should the question ever come before the Court.
But will it? This is not simply a question of jurisdiction, standing, or deference, to which I already alluded earlier in this post. Rather, events could simply overtake the situation, forcing a political and economic decision about the survival of the Euro before any additional legal questions reach to the Court. Paul Krugman wrote this week that the moment of truth in the crisis is fast approaching (‘we’re talking about months, not years’). No doubt, the survival of the Euro will require a serious commitment of financial resources by Germany, and the scope and manner of that commitment (should the Merkel government decide to make it) will clearly implicate constitutional limitations, as I previously outlined here. But as with much else in this crisis, the role of public law will probably not be center stage. Rather, it will likely operate primarily as a background limitation (no Eurobonds) or procedural constraint (increased Bundestag participation). But it will not likely serve as a basis for direct attack on the profound political, economic, and perhaps ultimately constitutional error that the EMU is shaping up to be.