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The German High Court, Eurobonds—and a New Euro Area Treaty?



In what could turn out to be a pivotal moment in the European debt crisis, the German Constitutional Court has upheld the constitutionality of German participation in the original Greek rescue package and its innovative twin rescue tools, the European Financial Stabilization Facility/European Stabilization Mechanism, or EFSF/ESM. As expected, the Karlsruhe Court—so named because it sits in the southwest German city of Karlsruhe—approved the measures supported by large majorities in the German Bundestag. But at the same time—as is traditional on EU-related rulings—the court laid down a series of democratic conditions for Germany's involvement.

The Court stated unambiguously that "[W]hen establishing mechanisms of considerable financial importance which can lead to incalculable burdens on the budget, the German Bundestag must therefore ensure that later on, mandatory approval by the Bundestag is always obtained again." In other words, the Bundestag must give parliamentary approval of any new EU "rescue mechanisms."

Moreover, the Court stated that "guaranteeing parliamentary budget autonomy requires … that the Federal Government is in principle obliged to always obtain prior approval by the [Bundestag] Budget Committee before giving guarantees." In other words, the German parliament must be consulted ahead of the commitment of any new fiscal guarantees by the German government.

Chancellor Angela Merkel will be quite satisfied with this verdict, as it does not pose insurmountable obstacles for the upcoming Bundestag vote on the changes to the EFSF agreed by euro area leaders on July 21 or prevent future German governments from joining another rescue at short notice. Yes, the Bundestag's Budget Committee might have to be on call for an emergency, but the Constitutional Court did not demand that the Bundestag act as a micro-manager of the EFSF/ESM.

Of much greater interest is the cloud cast by the ruling over Germany's possible future acceptance of eurobonds, the term for the proposed jointly guaranteed government debt that would be issued by individual euro area members. Here Karlsruhe was quite unambiguous, saying that "the Bundestag, as the legislature, is also prohibited from establishing permanent mechanisms under the law of international agreements which result in an assumption of liability for other states' voluntary decisions, especially if they have consequences whose impact is difficult to calculate." In non-legalize, eurobonds are not around the corner—a message the financial markets may not appreciate.

The prospects for euro area member states readily  guaranteeing each others' debt issuance, creating a single interest rate for euro area government debt, were always a fantasy dreamed up by people ignorant of the real world constitutional and political obstacles. The German Court now makes it clear that eurobonds today would be unconstitutional—and the German Court would surely not be the only in the euro area to reach that conclusion.

This situation need not doom the chances of establishing eurobonds at some point. They and the fiscal integration they would entail remain the most probable and effective way to guarantee the sustainability of the euro. Only bond traders possess the chutzpah to believe that Europeans would surrender their national sovereignty just because the bond traders recommend it.

What would be required for eurobonds, however, are changes to both the European Treaty and the German Constitution. This is a monumental but not impossible political and legal challenge for Europe in the years ahead.

Starting with the need for changes to the basic German law, or Grundgesetz, actually a relatively minor issue, as the German Constitution is among the most frequently altered constitutions in the European Union (EU).1 Recall how easy it was for Germany to enact its "Balanced Budget Amendment" in 2009. Changing the German Constitution would require a two thirds majority in the Bundestag and Bundesrat2. Certainly, the national constitutional constraints facing governments before they can sign up to eurobonds and the implicit pooling of fiscal sovereignty will be far higher in other euro area members than in Germany.

Even so, as witnessed by recent moves in Spain, Portugal and Italy toward enactment of their own "Balanced Budget Clauses," there is lately a greater willingness to change national constitutions to facilitate fiscal and economic integration in Europe.

The real political obstacle for eurobonds is the the EU Treaty, which would have to be amended. It took nearly 10 years to ratify the Lisbon Treaty in its current form. The pooling of fiscal policy and "economic government" entailed by eurobonds would require such far-reaching changes to the treaty that it seems doubtful that all 27 members would go along.

Actually the joint fiscal guarantees would only be relevant for the 17 members of the euro area. Thus the only realistic political option for eurobonds is to legally enable and implement them only for the euro area. This could be permitted by the Lisbon Treaty under the "enhanced cooperation procedure" specified in article 20 . The article enables nine or more member states to establish a deeper economic integration among themselves in areas (like fiscal policy or debt issuance) not governed exclusively by the Lisbon Treaty.

In reality, a new "Treaty of the Euro Area" (TEA) would be required to achieve a more fiscally integrated euro area, perhaps as part of a "two-speed-Europe" that would safeguard the euro indefinitely. The call for treaty changes by Chancellor Merkel in her speech to the Bundestag is an important marker for future political developments in Germany and Europe.

A separate new TEA would have numerous political advantages. Besides reducing the number required for ratification to 17, it would not require approval by the UK. Albion looks unlikely to join the euro for the foreseeable future. In addition, because TEA adoption would virtually guarantee perpetual government bond market access, notoriously ailing but referendum-happy Ireland could reasonably be assumed to approve it, too. A TEA would also satisfy the recent calls by the European Central Bank (ECB) president, Jean-Claude Trichet, for a "euro area finance minister" with the legal right to interfere directly in member states' budgetary and economic policies. It would further guarantee that the ECB would continue its current secondary bond market support for Italy and Spain. After all, the ECB's balance sheet would be secured, when existing bond holdings are converted into eurobonds.

Treaty changes, especially those concerning sovereignty issues like fiscal policy, take time to negotiate. Nevertheless, the likely incoming head of the euro area, Herman van Rumpoy, should start the process soon.

By the end of this year, euro area leaders should establish a euro area "Intergovernmental Conference" (IGC), the formal procedure for negotiating changes and additions to the founding treaties of the European Union. The IGC would work in close collaboration with all 27 EU members and the EU Commission to craft a TEA. The process, similar to the one that led to the original Maastricht Treaty for the euro in 1992, would lay down the political and economic requirements for euro area member states to participate in future national government debt jointly guaranteed by all member states. Probably, the European Court of Justice (ECJ) would be required to adjudicate legal disputes under the TEA as well.

Surely a TEA and Eurobond agreement are a minimum of 5-7 years away. But a relatively prompt establishment of an IGC tasked with its creation could have a powerful stabilizing effect in the short-term. A TEA would be Europe's strategic long-term political response charting the way out of the current crisis, while simultaneously ensuring that the ECB would do what needs to be done to stabilize things in the short-term.


1. The Grundgesetz has been changed 57 times since 1949.

2. Article 79 in the Grundgesetz.

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