Holding court over a brittle Europe

Europe's new bailout fund won't operate until approved by Germany's constitutional court, which may take months to reach a decision. But markets are increasingly fearful over Europe's ability to hold out.

Tensions on global financial markets intensified overnight as dismayed investors realised that it could be months before the eurozone’s new bailout fund – meant to act as a firewall to stop the debt and banking crisis from spreading – is up and running.

Overnight, German Finance Minister Wolfgang Schuble urged the Germany’s highest court, the Federal Constitutional Court in Karlsruhe, to reach a quick decision on whether the eurozone’s new bailout fund, and its proposed fiscal pact, are compatible with the country’s constitution. "Markets are very nervous”, he stressed. "The federal government does not want to exert any pressure – but it is a matter of weeks."

In his testimony to the court, Schuble warned that a lengthy delay "could cause further uncertainty on markets beyond Germany, and a considerable loss of confidence in the eurozone’s ability to make necessary decisions in an appropriate timeframe." He also warned that any suggestion that Germany wasn’t prepared to shoulder its responsibility for stemming the eurozone crisis "could exacerbate current crisis symptoms considerably." Some eurozone countries "would end up having further big problems financing themselves, which could raise questions over the stability of the eurozone as a whole."

But the Karlsruhe court appears determined to take its time in weighing up the complex legal issues involved in the case. It ended a 12-hour hearing overnight without setting a date for its decision.

Observers said that the court could take up to three months – much longer than the three weeks initially expected – to reach a decision to issue a temporary injunction on both the bailout fund and the fiscal pact. And it will likely take the court even longer to reach a final verdict on the issue at the heart of the case – whether Germany is ceding too much budgetary control to European authorities.

Investors are now fretting that there will be lengthy delays in launching the new permanent €500 billion ($US612 billion) bailout fund, which was set up to boost the eurozone’s ability to combat its deepening debt and banking crisis. Although Germany's parliament ratified the bailout treaty and the fiscal pact at the end of June, German President Joachim Gauck has delayed signing them into law until the Karlsruhe court makes its decision.

The new bailout fund can only start operating when countries accounting for 90 per cent of its capital commitments have ratified the bailout treaty. Since Germany is the largest contributor to the fund’s capital – accounting for 27.1 per cent, compared with 20.4 per cent from France, 17.9 per cent from Italy and 11.9 per cent from Spain – German ratification is crucial.

It was hoped that the new bailout fund, which was to have been up and running at the beginning of the month, would be able to help stabilise the Spanish banks, provide a bailout for Cyprus and additional aid to Greece and, possibly also, protect Italy from slipping deeper into crisis. The new fund will boast a capital base of €80 billion, which it will use to borrow up to €500 billion in financial markets. In addition, the fund will have an extra €250 billion in capital that is left in the eurozone’s current bailout fund.

The plan is for the bailout fund – which will be run by the German Klaus Regling, who is running the current rescue fund – to act like a European IMF, providing emergency loans for troubled countries. But, unlike the IMF, the new bailout fund will be able to buy the bonds of troubled countries, such as Spain and Italy, which will help reduce their borrowing costs.

In addition, at the last European summit, German Chancellor Angela Merkel – after intense pressure from France, Spain and Italy – finally agreed that the bailout fund would be able to directly recapitalise troubled banks without forcing the country concerned to request an official bailout, which involves the humiliation of being supervised by the 'troika' – officials IMF, the European Central Bank and the European Union. But Merkel insisted that this could only happen when there was centralised supervision of the European banking system.

Germany, meanwhile, has made sure that it keeps a tight rein on the new bailout fund’s spending decisions. The fund’s board of governors will consist of the finance ministers of all 17 eurozone countries. All decisions must be unanimous, except when the stability of the eurozone is at stake. In those cases an 85 per cent majority suffices. This gives Germany, along with France and Italy, the right to veto all decisions.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles