What a mess.
Today’s ruling by the German Constitutional Court (GCC), or Bundesverfassungsgersicht—even the name sits like some poison on the tongue—resembles a fishing exhibition to find some technicality to trip up the ECB’s public sector purchase program (PSPP).
Indeed, it feels like a marginal offside decision taken by the recently instituted Video Assistant Referee (VAR) in Association Football (aka Soccer). Though part of the striker’s shoulder had indeed drifted beyond the defender, it was a perfectly timed and bended run. The striker’s feet were clearly onside. Is it the offside rule that needs changing? Or should VAR be disbanded?
To wit, GCC couldn’t quite find anything wrong on ECB monetary financing or decisions potentially encroaching on the budgetary responsibility of Bundestag—crucial as these are. They instead picked holes in the “principle of proportionality”—the idea that EU institutions should only take necessary action within their remit, and not exceed their respective powers. More on this shortly.
But GCC was certainly on the prowl for more. On budgetary responsibility, it “is not ascertainable that the PSPP violates the constitutional identity of the Basic Law in general or the overall budgetary responsibility of the German Bundestag in particular… [if the PSPP] risk-sharing regime … were subject to (retroactive) changes, [it] would affect the limits set by the overall budgetary responsibility of the German Bundestag, as recognised by the Federal Constitutional Court’s case-law.”
In other words, don’t even think about making the German people responsible for the risk carried in the handling of peripheral government bonds!
It probably hasn’t been explained to those several Justices at GCC that Germany is worse off not sharing in the resulting coupons that accrue across the rest of the Eurosystem—while Bundesbank sovereign claims are pulled inexorably to par considerably from above, and German banks and citizens pay most for the negative interest that accrues on the accumulating liquidity.
Perhaps there is some comfort offered that the cost of default on these bonds will be avoided by the German taxpayer. But it has to be by now a coin toss between euroarea breakup or bond default if this possibility emerges any time soon. If so, cold comfort it will be when German losses through devalued TARGET2 credits are revealed.
In any case, this is not the point.
Perhaps the best way to review today’s decision is to step back and recall the timeline during March, when the original GCC ruling on PSPP was expected. To be precise, today’s decision was originally set to be announced on Tuesday March 24th. This was cancelled in order to prevent the spread of COVID-19—which is, of course, entirely reasonable.
But there might be more here than meets the immediate eye—if we might drift off into the realms of highly speculative, or even submit to conspiracy theory!
Recall four key dates in March. First, the ECB monetary policy meeting on Thursday, March 12th. Second, GCC delays the announcement of PSPP ruling on Monday, March 16th. Third, PEPP is initiated on Wednesday March 18th. Fourth, GCC ruling on Tuesday, March 24th which doesn’t happen.
What happened at the March 12th meeting of the ECB’s Governing Council? Well, there was the announced extension to the ECB’s asset purchase program of EUR120 billion. Then there was a press conference when, pressed about the role of OMT, President Lagarde famously noted “we are not here to close spreads.” With this, Italian yields jumped about 60bps across the curve by the next day.
Coincidence or otherwise, the following Monday, GCC announced—under reasonable cover of COVID-19—that the ruling on PSPP would be postponed until today, May 5th. Today being the day before the current President of the GCC retires—so it was delayed as long as possible under the stewardship of the existing President.
And what did today’s decision reveal. Well, amongst other things:
“The PSPP improves the refinancing conditions of the Member States as it allows them to obtain financing on the capital markets at considerably better conditions than would otherwise be the case; it thus has a significant impact on the fiscal policy terms under which the Member States operate. In particular, the PSPP could have the same effects as financial assistance instruments pursuant to Art. 12 et seq. ESM Treaty. The volume and duration of the PSPP may render the effects of the programme disproportionate, even where these effects are initially in conformity with primary law.”
What does this mean exactly? Well, it says that there are times when PSPP is consistent with the “principle of proportionality” and falls squarely within the ECB’s mandate of price stability. But there are other times where it might—just might—encroach upon competencies of other institutions within the EU. Whose competency exactly? Well, in this case the European Stability Mechanism (ESM) mandated under Article 12 to “safeguard the financial stability of the euro area as a whole and of its Member States, … [to] provide stability support to an ESM Member subject to strict conditionality, appropriate to the financial assistance instrument chosen.”
Put in simpler language, the ECB through PSPP is “not here to close spreads.”
It’s worth noting that the next (non-monetary) meeting of the Governing Council after March 12th was set for April 1st—of course, April Fools Day; why not? So the monetary policy meeting—the March-“we-are-not-here-to-close-spreads” meeting—was also the last opportunity, should it have been necessary, for German members of the Governing Council and Executive Board to provide what’s known in official circles as a “confidential and off-the-record briefing,” should it have been necessary, on what to expect from the GCC ruling that was scheduled in less than 2 weeks.
Clearly, the broad outline of the GCC ruling was decided many weeks before the emergence of COVID-19. And while such rulings are indeed confidential, it would not be unreasonable—given the sensitivities of the case—for the ECB to expect German members of the Executive Board and Governing Council to seek guidance on what might be expected. After all, this ruling would likely have a material impact on sphere of ECB decision-making.
The later Bloomberg kiss-and-tell on the mid-March COVID-inspired ECB policy U-turn suggested that Lagarde’s insistence that “we are not here to close spreads” was, perhaps, only parroting language used that same day by (German) Executive Board member Isabel Schnabel. But today we encroach upon an alternative possibility. Schnabel was herself simply summarising her own understanding of what the GCC ruling was expected to be later in the month, having dutifully sought off-the-record guidance as the German member of the Executive Board.
Let me stress the level of speculation involved here—this is guesswork on another level. On the other hand, I’m certain Ms. Schnabel will “like” the tweet associated with this diatribe to acknowledge the truth contained here-within. Nevertheless, the timing at least suggests that Lagarde was “that day in March” only trial-ballooning the legal constraints that were today unveiled as part of the GCC ruling. Indeed, as recapitulated today, GCC do not believe the ECB is there to close spreads. That’s the job of the ESM—precisely as Lagarde hinted.
Whether this is true—or, more reasonably, ought to be consigned to the conspiracy bin with stories of Elvis walking the streets of Reading and Slough—it cannot be overlooked that the following Monday the GCC ruling for later in the month was postponed, with coincident rising peripheral spreads and COVID-19 spread, as long as temporally possible. Meanwhile, perhaps mindful of the need to outrun the strictures laid out only today, the Executive Board of the ECB proceeded to develop a new instrument distinct from the PSPP to provide a fig leaf for the moment when the GCC ruling would inevitably emerge.
Thus, PEPP was born. Different to APP, yes. Designed to buy time from inception to legal ruling. Hopefully, the legal ruling on PEPP will emerge only after the crisis has passed. In which case it will provide a convenient excuse to absorb the considerable liquidity overhang that is emerging as Bundesbank is forced into monetary sterilization. In which case, happily ever after.
On the other hand, like the offside rule, when something doesn’t feel right it is reasonable to ask why there is something wrong. Is it the offside rule that’s the problem, or is it the people to interpret the rule? For those who seldom play football are apt to understand not the spirit but only the letter of the law.