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Wednesday, February 27, 2013

The inbuilt political stand-off in the ECB's bond-buying programme

One of the many sub-stories of the Italian election is how it calls into question the ECB's bond-buying programme - the Outright Monetary Transactions (OMT). Not so much because of the ECB's ability to expand its balance sheet and stand behind Italy and Spain (though there's a clear cost to that). The reason is another one: unpredictable politics.

This is something we highlighted immediately following Mario Draghi's announcement to launch the OMT, in September 2012. We said:
"It will also be virtually impossible for the ECB to impose effective conditionality on debtor countries, meaning that the ECB can only hope that a series of unpredictable political decisions in member states will go in its favour."
To inject such conditionality, the OMT was linked to the European Stability Mechanism - the eurozone's permanent bailout fund - which comes with strict conditions (or at least is supposed to). To tap the OMT, a country has to be on an ESM programme. But, in effect, this made the OMT - despite it being run by an independent central bank - hostage to parliamentary and electoral politics.

As we argued in our analysis on the German Constitutional Court ruling on the ESM - a few days after the OMT announcement in September last year:
"...the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto."
Well, enter the Italian elections (and Beppe). Discussing the election results, we told the Telegraph on Monday that:
“People have forgotten that the OMT cannot be triggered without a vote in the German Bundestag. This is going to be a huge problem, and we may be back to the political stand-off between the North and South of Europe,”
And in our flash analysis yesterday, looking at the Italian election results, we noted:
“A fragmented, anti-austerity Italian parliament could also make it far more difficult for the country to tap the ECB’s OMT. This is because it would need to access the European Stability Mechanism simultaneously, meaning a series of strict conditions – which Berlusconi and others could resist – and approval from several Northern Eurozone parliaments, including from the Bundestag.”
Other analysts are now waking up to this issue as well.

Then again, if it ever came to a point where Italy actually needed to tap the OMT, things might be so bad that politicians on both sides (probably during a panic-stricken weekend) could be scared into accepting whatever ESM-deal that could be struck.

But it all goes to show that in the eurozone, there's no escaping the politics.

5 comments:

Rik said...

ESM deals (and subsequently OMT) first go after parliamentary approval. And in Germany there is an election next September. The closer that date comes the more difficult it will be to approve any deal but certainly a deal without proper conditionality.
Doubtful if also an anything goes deal would make it in Austria, Finland and Holland. With the added problem that if there is doubt on that, markets will keep on being unstable until all formalities are met.

From the German Constitutional court rulings it is clear that the German parliament needs to keep grip on the spending. Doubtful if an anything goes deal will meet that requirement. As an anything goes deal would mean that Italian parliament would decide de facto, what according to the German Constitution is the right and duty of the German one. And if it gets to a referendum it is game over.

Anyway the final ruling from the German Constitutional Court is long overdue. This will most likely mean that it is troublesome to get to a final verdict. My guess there is a collission between what Buba powers could be transferred under the present constitution and what the ECB is proposing now.

This is first in line with earlier cases (and some extended interviews given on the issue, clearly to clarify).
But second any other ruling would be relatively simple. Basically copying the September one and stating that OMT is allowed (and you donot need at least 6 months for that).

While stating that the transfer of powers earlier were done and were considered allowed under the assumption that OMT things were impossible is definitely not an easy one. With basically it saying that:
-the rescuemechanisms have to be changed completely;
-the relation with the ECB would have to be changed (to make it constitutional again) plus safeguards for the future;
-timeframe for that given (probably 2 year);
-political implications thereof.

Last time I checked (a few weeks ago it was still not on the agenda of the Court).

Rik said...

A point I forgot to mention:

The OMT is based on an apparent transmission problem.
First of all after the Draghi Put and much lower S/I yields it appeared that the transmission was stil a problem. It is difficult to explain why buying bonds that does effectively the same thing as the Draghi Put will work where similar measures have completely failed.
Anyway in this respect have a look at a post on SoberLook about this issue will be from around september last year. Which also discussed this issue on more general terms (transmission not working).

Anyway this is moving into legal territory. Meaning one day left next day right should be off the table. Unless the law is changed there is basically just one way of doing things.

Which brings up the following. Even further extending OMT brings it even more clearly in 'Detournement de Pouvoir' country. Use of powers for other reasons than given. The more obvious it gets the more the German Constituional Court can decide for itself and would not have to refer to the ECJ. Furthermore the more it will raise doubt if the power transfer earlier from Buba to ECB was constitutional. And if not it either has to be reversed or the constitution has to be changed. The case from that time simply doesnot allow ECB to do effectively what it wants/sees as best. Beyond 'rasonable doubt'that is as nearly always on legal issues.

MoreLiver said...

Other similar views on OMT:
http://marketmonetarist.com/2013/02/28/its-frankfurt-that-should-be-your-worry-not-rome/
http://blogs.reuters.com/macroscope/2013/02/28/a-flaw-in-euro-zone-defences/

My thoughts from yesterday:
http://www.tradingfloor.com/posts/euro-zone-private-lending-falls-ecb-gets-excuse-1867705026

Patrick Barron said...

The history of the EMU and the ECB is that restrictive conditions are ALWAYS IGNORED! As the author of the blog states, the legislatures may be paniced into agreeing or, more likely, the ECB simply will ignore the law.

christina speight said...

One can go on endlessly examining the entrails of this slowly dying entity - the euro. What one cannot escape, however, is the inevitability that it will expire altogether. It is only held together by a fanatical belief in its fast-vanishing magic powers.

Please somebody acknowledge that the emperor has no clothes and kill it off before it reduces the whole of Europe to penury and destitution - and cripples world trade with it.