meaningful results



OMT and the ECJ (2)

Ultimately a country like, for example, Greece has to finance itself by issuing bonds to a private sector (commercial banks and other investors) who will be wary of Greece’s ability to pay its debts and want a high interest rate to compensate for the risk that they won’t get back the amount they’ve invested. Of course Greece can’t afford to pay a high interest rate, but the risk to investors – and so the interest rate Greece has to pay - can be reduced by the prospect of bailout funding from other member states with a better credit rating if things turn bad.

In these ‘bailouts’ the money comes from other member states, not the European Central Bank (ECB). But that also means that however large the fund, it is actually limited, and might not be enough to fend off speculative pressure and keep borrowing costs down on bonds issued by Greece by enough for the bailout to work.

Now because the ECB can create as much of its own currency as it likes its own funding capacity is unlimited, and so when its head Mario Draghi has promised to do ‘whatever it takes’ he means that if borrowing costs for a country that is being bailed out come under pressure the ECB will produce as much money as necessary and buy as many bonds issued by that country as necessary to keep that country’s borrowing costs down. This is called the Outright Money Transactions (OMT) scheme.

The rather large fly in the ointment is that the ECB isn’t actually allowed to finance member states, so cannot simply give Greece money in return for its bonds. So the ECB is saying to the private sector that if they invest their money in Greek bonds issued with a riskily low interest rate, then the ECB will take them off their hands at a price that will ensure they don’t lose any money.

This has been challenged before the German Constitutional Court, who has asked the European Court of Justice (ECJ) whether this cunning plan in fact breaches the ban on the ECB financing member states.

One of the main issues of substance before the court is that if this meant the ECB promising to take the bonds off the original buyers as soon as they bought them (which is about the only way of guaranteeing they won’t have to bear any risk) this would be just the same as if the ECB bought them directly in the first place. The Advocate General makes clear that this would be illegal, but to make it legal the ECB just has to wait for the bonds to settle to a ‘market price’ and it looks as though only a day or two might be an acceptable delay. Obviously there will be some risk for the original buyers that a cataclysmic event might occur during that period (like just happened when the Swiss stopped paying a guaranteed price for euros!) and while that make a bit of difference to the price, it doesn’t look as if that would be a show-stopper.

The second main issue is that the ECB is only allowed to conduct monetary policy and not economic policy. However, the ECB intends to use OMT to buy bonds issued only by member states who are already being bailed out in a financial assistance programme. That is, they are being helped out by the other member states in return for agreeing to ‘structural reform’. As structural reform is usually a euphemism for ‘cut public spending’ that could clearly count as conducting or directing economic policy. The Advocate-General makes clear that this is not on, and if OMT were put in place, the ECB would immediately have to stop its own involvement in the original financial assistance programme where it would previously have been a key player. It could not take an active part even in monitoring the progress of the programme.

The ECJ has now given its judgement (16 June 2015), and some initial thoughts on what it said about the main issues:

Can the ECB buy bonds straight from investors?

It might be better to call them 'investors' as the situation envisaged is that the private buyers of Greek bonds won't want to hold them for a moment longer than necessary, and the point of OMT is to reassure them that the  ECB will take them off their hands as soon as possible. Without that reassurance no one would buy them. The ECJ followed the Advocate General is saying that the 'investors' must take on some risk and actually hold the parcel before handing it on, because otherwise the ECB purchases would be indistinguishable from direct and unallowable funding of the Member State in question.

Will the German Constitutional Court be bound to follow the judgement? The ECJ says

14. the request for a preliminary ruling concerns directly the interpretation and application of EU law, which means that the present judgment will have definitive consequences as regards the resolution of the main proceedings.

I'm sure it will have definitive consequences, but it remains an open question whether it will be determinative of the proceedings in Germany. As pointed out previously, the German Constitutional Court said that they would treat the ECJ ruling as only ‘in principle … a binding interpretation of EU law’. And the clear implication in their concern with 'the consequences which the contested act is said to entail for the national constitutional body which is first and foremost responsible for expressing the will of the citizens' is that the will of the German citizen is paramount.

Is OMT economic policy?

The ECB's role is restricted to monetary policy, and specifically to using this to ensure price stability within the eurozone. The Advocate General's opinion was that although OMT was a legitimate part of monetary policy, if it were carried out in conjunction with continued 'conditionality' being applied to how the Greek government ran its economy, then the ECB would have to stop any involvement with the latter.

The ECJ doesn't address the issue of whether, if the ECB were buying bonds on the secondary market, it would have to keep out of any involvement in any financial assistance programme, whether linked or not. This might seem surprising in view of the importance the Advocate General attached to this issue. The court's silence on the issue of the ECB's involvement means that this could be argued either way.

Instead, in rather discursive passages the court points out that although monetary policy might have economic impacts this doesn't make monetary policy into economic policy. That must be true enough, but if pushed to its logical conclusion it might suggest that anything can done in pursuit of price stability without it counting as going beyond monetary policy and becoming a matter of economic policy.

However, the court makes clear in paragraphs worth quoting in full

112    In that regard, it must be borne in mind, first, that the programme provides for the purchase of government bonds only in so far as is necessary for safeguarding the monetary policy transmission mechanism and the singleness of monetary policy and that those purchases will cease as soon as those objectives are achieved.

113    That limitation on the ESCB’s intervention means (i) that the Member States cannot, in determining their budgetary policy, rely on the certainty that the ESCB will at a future point purchase their government bonds on secondary markets and (ii) that the programme in question cannot be implemented in a way which would bring about a harmonisation of the interest rates applied to the government bonds of the Member States of the euro area regardless of the differences arising from their macroeconomic or budgetary situation.

114    The adoption and implementation of such a programme thus do not permit the Member States to adopt a budgetary policy which fails to take account of the fact that they will be compelled, in the event of a deficit, to seek financing on the markets, or result in them being protected against the consequences which a change in their macroeconomic or budgetary situation may have in that regard.

This does seem to set limits on "whatever it takes", or rather begs the question of "Whatever it takes to accomplish what? On the one hand whatever it takes to ensure price stability etc is clearly allowed, but on the other hand not to the extent that a Member State would be guaranteed protection against the consequences of its budgetary choices. This seems paradoxical if the need for OMT arises principally, if not entirely, from the need to protect Member States from just such choices.

However, in saying that the interest rates that governments have to pay on the bonds they issue must to some extent at least reflect their respective macroeconomic and budgetary situations there is wriggle-room in the choice of the word 'harmonisation'. Is that to be interpreted literally as meaning using OMT to make interest rates identical, or more generally as bringing interest rates closer together. The latter seems preferable,  as there cannot be any realistic intention or expectation that OMT can or should bring interest rates of German and Greek bonds in line. But if the court means that OMT cannot be used to bring interest rates any closer together than is justified by their respective macroeconomic and budgetary situations this again this seems to beg a question - of what interest rate would reflect the Greek macroeconomic and budgetary situation. And arguably this must be the rate absent interventions like OMT.

Overall, then, there must be some uncertainty whether the ruling actually directs or constrains the German Constitutional Court, because by stating the legal position it seems to leave open to the German court at least the possibility of making findings of fact about the OMT proposals or indeed about the macroeconomic and budgetary situation in Greece (or other Member States) that could lead to a decision either way on the issues in front of it...