The bond purchases themselves will not be conducted by the
ECB, but rather by the national central banks in proportion to their capital
key with the European Central Bank. Hence,
should Spain eventually fall under the OMT program, it will be the German Bundesbank
that will be responsible for purchasing the largest single share of Spanish
bonds.
While couched as a means of restoring monetary transmission
policy, Draghi himself describes OMT as a “fully effective backstop removing
tail risk for Europe.” In reality, this
backstop effect is achieved through the ECB's taking on the role of sovereign lender of last resort. Restoration of monetary transmission policy is
merely a fig leaf. If the OMT was truly
aimed at restoring monetary transmission policy, the conditionality would not
be present.
But, is OMT legal under the treaties that govern the ECB?
The letter of the
law:
Treaty on the Functioning of the European Union (TFEU)
Article 123 (ex Article 101 TEC)
1. Overdraft facilities or any
other type of credit facility with the European Central Bank or with the central banks of the Member
States (hereinafter referred to as ‘national central banks’) in
favor of Union institutions, bodies, offices or agencies, central
governments, regional, local or other public authorities, other bodies
governed by public law, or public undertakings of Member States shall be prohibited,
as shall the purchase directly from them by the European Central Bank or
national central banks of debt instruments.
Statute of the European System of Central Banks and of the European
Central Bank (Statute of the ECB)
Article 18
Open market and credit operations
18.1. In order to achieve the
objectives of the ESCB and to carry out its tasks, the ECB and the national
central banks may:
- operate in the financial markets
by buying and selling outright (spot
and forward) or under repurchase agreement and by lending or borrowing claims
and marketable instruments, whether in euro or other currencies, as well as
precious metals;
- conduct credit operations with
credit institutions and other market participants, with lending being based on
adequate collateral.
Article
21.1 of the ESCB Statute also applies, but is a direct quote from Article 123
of the TFEU.
With regard to the conduct of outright monetary
transactions, it is obvious that the ECB indeed does have the authority under
article 18.1 to buy and sell outright in the financial markets. It is equally
obvious that neither the ECB nor the national central banks have the authority
to purchase sovereign debt in the primary market. In his press conference, Mr. Draghi himself
assured us of the legality of OMT in the following statement:
“…
we are sure that we are acting within our mandate, that we are not violating
Article 123. It is pretty explicit: it says for purchases on the primary
market, this is a violation, not for purchases on the secondary market as I
have stated this program will work. And incidentally, outright purchases of
bonds are identified, in Article 18 of the Statute of the ECB, as one of the
various possible tools that our monetary policy has and can use. So we are not
creating anything new here. “
Note Mr. Draghi’s clever omission of the prohibition against
the ECB or any national central bank establishing a credit facility in
favor of central governments, as spelled out in that same Article 123.
Thus, the crux of the argument: is the OMT program a credit
facility in favor of central governments, as prohibited by Article 123 of the TFEU,
and Article 21.1 of the Statute of the ECB?
It depends on how you define a credit facility. Most simply, a credit facility is an entity
that facilitates access to credit. When
a country sells its sovereign debt, it is essentially asking funding sources in
the primary market to extend it credit. Creditors
will demand a certain interest rate in return, depending on the sovereign’s
growth prospects, existing debt levels, primary budget balance, default history
and risk, loan term, and other factors. These
interest rates become part of the contractual agreement between the sovereign
and the entity extending credit. In some
cases, these interest rates may rise to a level that prohibits the sovereign
from obtaining credit from the market.
With the OMT program, the ECB has essentially said that any
European Monetary Union sovereigns unable to obtain favorably priced credit
from the market may apply to the ECB in order to obtain that credit in
unlimited quantities, albeit via debt purchases in the secondary market. Now,
pray tell, how is a backstop facility that will indirectly fund unlimited government
borrowing for below-market rates not a “Credit Facility” and not “in
favor of a central government?”
This clearly means
that the ECB will have established a credit facility in favor of the sovereign
participating in the OMT program, and that is an explicit violation of the
letter of the law.
But ... “Does the end
justify the means?”
Jaywalking is illegal. However, the individual who jumps out into the
street to rescue a toddler playing in traffic is unlikely to be arrested. In this case, the end justifies the means.
Torture is illegal in most Western countries. However, let's presume you have a suspect in
custody who you believe to have planted a nuclear device somewhere in a large
city. Under such circumstances, is it acceptable
to water board that individual? Would
tooth extraction, pulling out fingernails, or other means of physical mutilation
be justifiable?
Obviously, the last example does not allow for the easy
answer the first did. However, what both
examples share in common is the existence of what are known as extenuating circumstances. The question to be answered in both examples
is whether the circumstances under which the violation of law took place were
extenuating enough to justify the transgression. Asked in another way, was the intent of the
law preserved even though the letter of the law was broken?
But what if we have a condition in which the intent of the
law was to specifically prohibit justifying its violation under a pre-envisioned
set of circumstances? What if the whole intent of the law was to
guard against a specific set of circumstances ever being used to justify its
transgression?
“The history of past real or quasi monetary union of sovereign states suggests
that the build-up of severe fiscal imbalances in parts of the union and the
monetization of these deficits have been the key reasons for failure. Mindful of
the past experience, the fathers of EMU wanted to shield the central bank from
any pressures to monetize fiscal deficits and hold countries responsible for
their financial behavior. To achieve the first objective, the ECB was prohibited
to purchase government bonds in the primary market and given far reaching
independence in the Maastricht Treaty that constituted EMU. To achieve the
second objective, the Stability and Growth Pact was concluded with the aim to
prevent governments from running up excessive fiscal deficits. In addition, the
threat of default was expected to exert further disciplinary influence on the conduct
of fiscal policy.”
Thus, Germany
agreed to relinquish the Deutsche Mark on the condition that the new currency
area would not lead to direct or indirect socialization of its members' debt,
thus precluding any financial assistance from EU funds for states facing
bankruptcy.
If we accept that
this was the explicit intention of the framers of the Maastricht Treaty, then
we have to admit that the extenuating circumstances of a member state unable to
fund itself in the primary market cannot be used to justify a violation of the
Treaty. These were the exact pre-envisioned circumstances the law intended to
prevent from ever being used to justify an extenuation.
Germany demanded the inclusion of Articles 123 and
125 of the Treaty on the Functioning of the European Union with the clear
intent of protecting itself and its citizens from responsibility for the fiscal
failings of other member states. Hence,
OMT violates the intent of the applicable laws.
Conclusion: The OMT
program is in violation of both the letter and the intent of Article 21 of Statute
of the European System of Central Banks and of the European Central Bank and of
Article 123 of the Treaty on the Functioning of the European Union (TFEU). Furthermore, Article 122 of the TFEU, which
has been invoked to justify fiscal transfers under the EFSF, does not
apply as it specifically states that Union financial assistance to “a Member
State [] in difficulties or [] seriously threatened with severe difficulties
caused by natural disasters or exceptional occurrences beyond its control” may
be granted by the European Council,
on a proposal from the European
Commission. ECB actions are NOT covered under this exceptional circumstances
clause.
Recommendation: A party
with standing before the European Court of Justice should bring suit to request
an emergency injunction forbidding the European Central Bank from pursuing its
illegal Outright Monetary Transactions program.
I nominate Jens Weidmann and the Bundesbank.
* These conditions can include either participation in a
full EFSF/ESM macroeconomic adjustment program, or in a precautionary program,
such as an Enhanced Conditions Credit Line, as long as the precautionary
program includes the possibility of EFSF/ESM primary market purchases. The
assistance of the IMF will be sought for the design of country specific
conditionality and the monitoring of program compliance.
ED NOTE: An edited version of this article appears on Wolf Richter's Testosterone Pit.
