EU Bank Cleared to Buy Troubled Gov’t Bonds

     (CN) – A plan hatched by the European Central Bank in 2012 during the global financial meltdown to buy troubled government bonds is constitutional in principle, an adviser to the EU’s highest court found Wednesday.
     Political leaders and economists in Germany sued their own government, the Deutscher Bundestag, over its failure to challenge the ECB’s plan – which has never been legally adopted, much less implemented.
     The German group claimed that their fundamental rights had been violated by the Bundestag’s failure to act, and the parliamentary group Die Linke asked the German constitutional court to order lawmakers to work on annulling the ECB’s plan.
     For the first time in its history, the highly independent German court asked the European Court of Justice to weigh in on the legality of the plan, known as the OMT program. Specifically, it questioned whether the plan is an economic policy measure rather than a monetary one, therefore exceeding the scope of the ECB’s powers under the EU constitution.
     The ECB acknowledges that the program is an “unconventional” instrument – and risky – but argued that it falls within the bank’s constitutional mandate. It argued that the plan would restore the efficiency of its monetary policy instruments by lowering the interest rates on member state bonds, thereby stabilizing Europe’s financial situation in the event of a fiscal crisis.
     But while both the groups challenging the plan and the German court believe the OMT program would make the ECB a “lender of last resort” in the euro area, Advocate General Pedro Cruz Villalon said the ECB’s broad discretion to implement EU monetary policy limits judicial review of its decisions.
     Villalon agreed the OMT is unconventional, but also pointed out that few details about the plan have been shared since it’s never been adopted or implemented. He also noted that if the program is to remain a monetary instrument as the ECB claims, the bank must not be directly involved in any financial assistance programs of member states.
     The adviser for the Luxembourg-based court also acknowledged that the EU constitution prohibits the ECB from purchasing bonds directly from member states. But the bank can legally conduct business on the secondary market – provided it can show that it has implemented safeguards to prevent direct monetary financing of individual states.
     Villalon also dismissed worries that the ECB’s tinkering in the secondary bond market could lead to its insolvency due to the risk of buying bonds from a government in fiscal dire straits.
     “It is widely accepted that the fact that a state has liquidity problems does not necessarily mean that it is going to default on its debt,” Villalon wrote in the 37-page opinion. “A state may be subject to temporary liquidity problems and, at the same time, be a solvent state. Therefore, the fact that the OMT program is targeted at bonds issued by a state or states that are subject to a financial assistance program does not automatically mean that those states are going to default, in full or in part, on their debt. The fact that the states concerned are subject to a conditionality intended to improve their macroeconomic fundamentals, together with the fact that they are integrated in an internal market in the framework of a union based on a spirit of cooperation and loyalty amongst its members, rather tends to confirm that a financial assistance program provides the state concerned with sufficient support to enable it to meet its obligations in the future.”
     But the adviser also urged the ECB to pull out if it ever detects a marked increase in a member state’s debt or if the bank itself faces possible insolvency.
     “Obviously that is an assessment that relates to a scenario in which the OMT program is implemented,” Villalon wrote. “However, I consider it essential, if the strict proportionality of that program is to be confirmed, that the limitation of risks as explained by the ECB should actually be put into practice once the time comes to implement the program.”
     And should the program ever be implemented, the adviser said there must always be a distinction between the primary and secondary bond markets in order to be constitutional.
     Villalon also questioned whether the Court of Justice should even take up the case given the “functional difficulty” of the preliminary ruling request – which contained indications that the German court would make its own decision in the case, regardless of the EU high court’s answer.
     “A national court should not be able to request a preliminary ruling from the Court of Justice if its request already includes, intrinsically or conceptually, the possibility that it will in fact depart from the answer received,” Villalon wrote. “The national court should not be able to proceed in that way because the EU constitution cannot be regarded as providing for such a possibility.”
     Villalon’s opinion is not binding on the Court of Justice, which has already begun its deliberations in the case.

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