Walking A Tightrope – German Supreme Court Hearings Begin
Germany's constitutional court in Karlsruhe will begin hearings on the complaints filed by the group of legal scholars and economists led by Karl Albrecht Schachtschneider as well as the separate complaint filed by CSU politician Peter Gauweiler (who already has a partial victory under his belt from his complaint against the Lisbon treaty – we discussed Gauweiler's case previously, in Gauweiler's Challenge and an update thereto).
Schachtschneider's group and Gauweiler both opine that the bailout fund for the peripheral sovereigns is in conflict with German constitutional law as well as existing EU treaties. As we noted in our previous missives, when the bailout fund (EFSF) was originally created, the euro-group used the obscure article 122 of the Lisbon treaty as its legal justification. This article was actually meant to enable help to be extended to EU member nations in case of natural disasters. Obviously, fiscal profligacy leading to national bankruptcy is a disaster, but it is clearly a man-made one. In its decisions on the previous complaints, the court tended to side mostly with the government, but it did insist that German sovereignty and the German constitution must take precedence over the European project.
Court decisions usually are not merely a matter of a strict interpretation of law. Rather, they generally also tend to reflect the social mood of the day, which influences judges just as much as the population at large. In this sense, the latest complaints have a better chance at succeeding than the previous ones (the group around Schachtschneider tried to torpedo the creation of the euro from the start, but obviously failed to get a favorable ruling). Public opinion has changed markedly over time and anti-euro sentiment is at the moment relatively rampant. In addition, the plaintiffs can point to the fact that the predictions they made way back in 1998 have indeed come true – with eerie precision as it were.
Most observers agree that the court will likely attempt to avoid creating chaos in financial markets by retroactively disabling the already existing bailout arrangements. When the court refused the motion for a preliminary injunction against the first Greek bailout, it specifically cited the government's objection that such an injunction would upset the markets and be followed by 'unforeseeable consequences'. However, there can be no doubt that the bailouts stand on a flimsy legal basis, so the court's decision will likely limit the government's flexibility in the next iteration of the crisis. What we found most interesting in this context was an interview Mr. Schachtschneider gave to the 'Frankfurter Allgemeine Zeitung' (FAZ), a well-respected German daily. You can see the original here.
We provide a translation of the salient points below:
Q: 'Do you want to make history as the man who interred the euro?'
A: 'I'm opposed to the euro, wholeheartedly. Nonetheless I'm a friend of the European Idea. My wife and I have been married in Rome, my daughter was baptized there, I appreciate the diversity of European culture. That is precisely why I want to live in a commonwealth of free European states, not a forcibly united European federal state that is based on destructive economic illusions.'
Q: 'Since the euro crisis began, you sound triumphant like Cassandra, who sees herself vindicated'
A: 'Triumph is the last thing on my mind. But I do like to point out that what is happening now is exactly what we predicted in in our complaint against the euro in 1998. This crisis was inevitable. Agrarian and tourism-dependent nations can not be united in a workable currency union with a strong industrial nation like Germany.'
Q: 'The hearing in Karlsruhe [seat of the constitutional court, ed.] is not about whether euro rescue makes economic sense, it is about the question of its constitutionality.'
A: 'Certainly. For me as a jurist, the question of the law is the most important one. But the euro adventure must be ended on the grounds of economic reason alone. I have made a bet with my fellow plaintiffs: which law will end the euro first, economic law, or juridical law. At present there is a chance for jurisprudence.'
Q: 'Your complaint has 225 pages. What is your main argument against the euro rescue?'
A: 'It is in conflict with fundamental requirements of the European treaties and the structural principles of the currency union, namely against the proscription of assuming the liabilities of other nations. The rights and duties of the ECB were also violated.'
Q: 'But the German constitutional court does not have authority with regards to contraventions of European law.'
A: 'The breach of law is so obvious that the judges won't even need to interpret the treaties. All they need to do is read them. French finance minister Christine Lagarde [lately leader of the IMF, ed.] openly admitted that the treaties are being violated.'
Q: 'Still, the court doesn't even consider these rules. Besides, a new treaty is already in the works.'
A: 'Why does the permanent stability mechanism require new rules? Allegedly the old ones are sufficient. If this were only about European law, the court would have immediately referred our complaint to the European court. It hasn't done that though, luckily. Nobody is interested in fundamental rights there.'
Q: 'What violations against German constitutional law are you challenging?'
A: 'Where do I begin? What is violated is the fiscal and budgetary sovereignty of parliament. What is violated is the principle of limited borrowing – through the rescue attempts, Germany is taking on debt beyond the limits set by the constitution. What is also violated is the principle of social stability. The government is putting Germany into a precarious financial position.'
Q: 'Those are abstract principles. Where is the infringement of your rights?' [this question relates to the fact that in order to have standing, a complainant to the constitutional court must prove his rights were violated, ed.]
A: 'Our rights are violated because the power of representation we citizens have given the State has been exceeded. The Greek rescue establishes a liability, debt and financial union, the decisive step toward a federal European State. It becomes an irrevocable reality once the permanent rescue mechanism has been established. However, politicians may not dispose of Germany's statehood. That is something the people would have to decide in a referendum.'
Q: 'Germany doesn't lose its statehood just because we guarantee loans to other nations.'
A: 'I see it differently, because these giant bailout funds exceed our capacity. The rescue package represent in any event a 'legal act that breaks the mold' – a clear violation of democratic principles.'
Q: 'Can an individual citizen even denounce the breach of an abstract rule like the democratic principle before the court?'
A: 'Yes, this was one of the great successes of the Maastricht suit, that citizens have been accorded a new fundamental right. The judges have determined that the democratic principle has a subjective component. Every citizen has the right to democracy and can complain against legal acts of the Union that break the mold.'
Q: 'The Bundestag [parliament, ed.] has agreed to the rescue package for Greece last year. Isn't that democratic enough?'
A: 'That is the big question that will hopefully be cleared up in Karlsruhe. Do we citizens have a right that the Bundestag acts in accordance with the law, or only that it acts at all? In my opinion, we don't vote for representatives so that they can then violate the constitution. Unfortunately one can expect a courageous 'no' only from very few of them.'
Q: 'The judges may say: in that case, vote for more courageous representatives.'
A: 'Even if they say that – they can not possibly assent to the fact that the Bundestag issues a blanket authorization for Germany to supply € 190 billion to the permanent bailout fund. At the very least, the representatives will have to approve every single tranche. Or should our budget depend on the fiscal policies made in Athens?'
Q: 'The bailout funds are after all tied to tough conditions'
A: 'That makes the violation even worse, in my opinion. In order to rescue the euro, we intervene in the fiscal policies of other nations. Not even our federal fiscal equalization scheme goes that far. Imagine if rich Bavaria were forced to buy the bonds issued by Saarland, and in exchange could then dictate to Saarland what it could spend the money on.'
Q: 'The government will probably argue that without a bailout, other nations will also get into trouble'
A: 'Systemic relevance is not a legal principle! Even Deutsche Bank is replaceable. It is intolerable that the billions in bailout funds flow into the coffers of banks and insurance companies. In a free market economy based on contracts and property rights, private creditors must bear their risks themselves.'
Q: 'What happens if you're successful? The judges will hardly be able to put the rescue fund out of commission.'
A: 'They could declare the bailouts to be unlawful and demand a new contractual basis for further measures – and a referendum over such a new treaty. That would be the best solution. Politicians fear nothing more than direct democracy.'
Q: 'Are you afraid that political pressure will be brought to bear against the judges?'
A: 'The president of the court is still young and has only been in office for a short period of time. My hopes are more with the juridical consciences of his colleagues in the senate [the congregation of constitutional judges is referred to as 'the senate' in Germany, ed.]. Political pressure exists, I have no illusions about that. Judges have telephones. Against this, I can only use judicial dogmatics and appeals to reason.'
So much for Schachtschneider's point of view.
Greek Farce In Fine Fettle
In the meantime, it has ironically become known that Greece has once again breached the conditions of its bailout during the just expired month of June. According to Marketwatch:
“Greece is at risk of missing a key budget target in June, European Union experts said in a report, a sign of the uphill struggle the country faces as it tries to get its deficit reduction plans back on track.
The report, prepared by European Commission budget experts with input from European Central Bank officials and published over the weekend, says that Greece could miss its June target for its primary budget balance, a measure of the government deficit that excludes interest payments on outstanding debt.
Government revenue faces "significant" shortfalls that have only partially been offset by lower spending and delayed payments, the report says. "As a result, the quarterly performance criterion on the primary balance could be missed already in June."
You couldn't make this up. Adding fresh complications to the situation, Standard & Poors has let it be known on Monday that the French plan for a 'Greek SPV' to enable a default that will escape being called a default, will still lead to the agency rating Greece's existing debt as being in 'selective default'. Unfortunately for the eurocracy, this formulation does evidently not get rid of the 'D' word.
As Reuters reports:
“European share prices were flat on Monday and on course to snap a five-session rally after credit rating agency Standard & Poor's raised fresh concerns over private sector involvement in a second Greek bailout package, hitting banks sharply after a strong rally last week.
S&P said current French plans to roll over Greek debt held by private banks would likely constitute a "selective default", increasing uncertainty over the structure of a future debt deal and prompting profit-taking among major banking stocks.
“The primary concern with the Greek situation is the rolling (over) of the debt, and how much time we've actually bought ourselves in the interim. The comments don't really help," said a London-based trader at a U.S. investment bank.
The S&P comments "do puncture some of the enthusiasm that was built up last week", added Keith Wade, strategist at Schroders.”
'Punctured enthusiasm' simply won't do. Everybody just bought into the rally, didn't they? The credit rating agencies have become veritable party poopers, which is an entirely newfangled role for them (previously they were better known as party enablers).
Naturally, this once again brings the question to the fore of what to do about the ECB's hitherto firmly held stance, namely that bonds bearing the dreaded 'D' (and we suppose, 'SD' isn't much better) can not be used as collateral in repos with the central bank. The most amusing comments on this particular conundrum have found their way to the FT's Alphaville blog (as an aside here, many observers have remarked in recent months that it is no longer so easy for fund managers to produce what is colloquially known as 'alpha', due to the strong correlations between individual stocks, stock market sub-sectors and other so-called 'risk assets'. Perhaps it is time to think about renaming a few places on the inter-tubes. We're not entirely sure, but the time may have come for 'Betaville blog' and 'Seeking Beta' – just saying).
As the Alphaville blog notes in 'The French proposal, c'est un défaut sélectif', first quoting the missive from S&P:
“This credit comment looks at the most prominent of the recent proposals, put forward by the Federation Bancaire Francaise (FBF) on June 24, 2011, in the context of our criteria for evaluating distressed debt exchanges and similar debt restructurings (see Related Research below). In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria.”
The remainder of the credit comment looks at the whys and wherefores of this assessment, which mostly consist of noting that creditors would definitely lose out under the French plan, which leads to the conclusion that:
“Taking these considerations into account, we believe that both options represent (i) a “similar restructuring” (ii) are “distressed” and (iii) offer “less value than the promise of the original securities” under our criteria.”
That sounds rather definitive and we have often pointed out that the problem of how the credit rating agencies would view an allegedly 'voluntary' haircut suffered by private creditors would continue stand in the way of all such plans. Of course we think that the best way forward would be to finally get it over with. We agree with the views of Mr. Schachtschneider in this respect – creditors have voluntarily taken a risk and it is time they faced up to the consequences.
Now we come to the funny part – Alphaville quotes Gary Jenkins from Evolution Securities on the matter:
“As the proposal not triggering a default was set as a precondition by the FBF [French banking federation, ed.] it looks like it might be back to the drawing board.
Or the ECB backs down and states that it will continue to accept defaulted bonds as collateral and the FBF ignores its own terms and conditions. We are in such strange and dangerous times that anything is possible. It might be that a completely different form of bail out has to take place, such as guaranteeing Greek debt or buying it back.
Anyhow, this is certainly a brave decision by S&P and it will be interesting to see how the others follow and how senior officials at the EU react. Bet they wish they had gone ahead and set up their own rating agency now….”
Neil Hume then dryly remarks:
“The ECB accepts defaulted bonds as collateral. Now, there’s a thought.”
To which we say, 'why not?' After all, the central bank is already a repository for tens of billions of Greek bonds which it has bought in the course of its bond market manipulation program (a most spectacular failure so far, as it were), and if there were no bailout, these bonds would most definitely be rated 'D' already. The ECB does of course have certain rules about what collateral it accepts, but as we have previously mentioned, it has in any event become Europe's biggest 'bad bank' by now. Since the national central banks in the euro system – officially arms of the ECB – decide for themselves what collateral to accept in bank funding operations, all sorts of toxic trash has been created by the banks specifically for the purpose of unloading it on the ECB. The ECB not only has bought Irish, Portuguese and Greek bonds with abandon, it also holds the some € 360 billion in 'non-marketable assets', € 480 billion in 'asset backed securities' , and the Irish central bank holds a € 80 billion IOU issued by insolvent Irish banks to it somewhere under the heading of 'other assets' (there will be a degree of overlap between these various categories, so one shouldn't simply add them up).
Reading this, some people will surely wonder how it can be that the euro is now 'backed' by all this dubious debt and still trades at the lofty heights it currently inhabits relative to other currencies. There is a certain fine point worth considering here that prompted our 'why not' question above. The fact of the matter is that the euro – and the same is true of any other fiat money – is not 'backed' by anything. It just is, because the State says so (that is what 'fiat' money means – 'let there be this thing called money'). Whatever trash inhabits the asset side of the central bank's balance sheet is utterly irrelevant in this context. No-one can present their euros to the ECB and redeem them for anything other than euros. The currency was, is and will remain irredeemable. Its value is solely derived from legal coercion and the resulting fact that is the only money suitable to 'extinguish debts both public and private'. The main reason why the ECB is so steadfast in its refusal to accept Greek bonds rated 'D' in its funding operations is probably that it wants to keep up pretenses. The fiction that the money it issues is actually more than it really is must be preserved, as ultimately the currency still depends on the confidence of its users.
What prompted us to think about the issue was a recent proposal by Ron Paul of how to resolve the US debt ceiling impasse in a creative manner. As he noted, the Federal Reserve owns $1.6 trillion in government bonds, and since the Fed is an arm of the government, why not simply cancel them? Presto, debt ceiling problem solved for at least another year or so. We wonder how this idea was greeted at first. We're imagining a moment of astonished silence. What, we actually do owe it to ourselves? Of course the purchases of the Fed are 'financed' by the 'inflation tax', so to speak. There is the idea that one day, the Fed might want to sell some of these bonds again in order to extinguish the bank reserves and new deposit money it created by buying them. Aside from the fact that the idea that the Fed would ever willingly shrink the money supply is preposterous a priori, Dr. Paul points out that there are effectively no constraints on how the Fed might go about 'draining liquidity'. It could for instance increase reserve requirements. In the end, it does not really matter if its assets are partly composed by $1.6 trillion in treasury bonds or a piece of paper which Ben Bernanke's children have inscribed with '$1.6 trillion IOU' with colored crayons. The US dollar would be equally irredeemable in either case. Ron Paul presumably knows very well that his proposal doesn't stand a chance of being adopted, but it is a clever way of reminding people of the nature of the modern-day monetary system.
Below are is our usual collection of charts of CDS and bond yields in the euro area – as can be seen, the post 'Greece is saved' enthusiasm has not been punctured as much as feared by S&P's announcement regarding the French plan. The pullbacks in all the peripheral bond yields and CDS on these bonds have been quite steep, and there was only a tiny bounce occasioned by the rating agency's stern rebuke. Risk still seems 'on' for now. CDS prices and yields in basis points, color-coded.
5 year CDS spreads on Portugal, Italy, Greece and Spain – a small bounce after a spirited pullback – click for higher resolution.
5 year CDS on Ireland, France, Belgium and Japan – click for higher resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for higher resolution.
5 year CDS on Latvia, Lithuania, Slovakia and Slovenia – click for higher resolution.
5 year CDS on Romania, Poland, Estonia and Slovakia – click for higher resolution.
5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – as previously noted, it's 'all one credit market' and CDS on Turkey's debt specifically seem closely correlated with Western European ones.
10 year government bond yields of Spain, Portugal Ireland and Greece. Eurocrats are probably breathing a sigh of relief that Spain's yields are back in their previous trading range for now. The genie and the bottle come to mind.
10 year government bond yields of Italy, Austria, UKL (gilts) and the 2 year Greek note yield. Quite ironically, UK gilts and Austrian government bonds are regarded as 'safe havens' during euro area debt turmoil and tend to see their yields rise whenever the 'risk on' trade comes back – click for higher resolution.
The SPX and the AUD-JPY cross rate – still moving largely in tandem so far, but we're keeping an eye on the next potential divergence – click for higher resolution.
The SPX, T.R.'s VIX-based proprietary volatility indicator (adjusted by the gold-silver ratio), the SPX-gold ratio and the gold-silver ratio itself. The latter is the only fly in the ointment here, as it still refuses to decline – i.e., it has failed to confirm the rally in stocks so far – click for higher resolution.
Lastly, here is a weekly chart of silver, which curiously is once again precariously poised just above important short term support (both a lateral support level and the 50% retracement level of the major August 2010- April 2011 rally leg). This is curious because silver normally tends to be firm when the stock market rallies, so this represents a bit of a rally non-confirmation (along with the gold-silver ratio). On the other hand, precious metals stocks have positively diverged lately, so perhaps this support will hold again – click for higher resolution.
Charts by: StockCharts.com, Bloomberg
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