The hearing will potentially be a top item on the financial markets’ radar in the coming days.

In the fall 2012, all we talk about was a constitutional court. Not Turkey’s but Germany’s. Due to the European crisis, European leaders had held a number of meetings. In the one held in December 2011 leaders decided among others to put into operation the European Stability Mechanism, the permanent body that will replace the temporary European Financial Stability Fund in July 2012 instead of 2013. The advantage was that if opened earlier, the Stability Fund would be larger. Moreover, the temporary fund relied on guarantees and did not have fresh funds while the Stability Fund would have fresh funds. The positive mood enabled by this decision and others melted into air in a couple of days.

The reason was that the whole world was waiting for the words of the Germany’s Constitutional Court for putting the permanent fund into operation. A group of academicians had applied to Germany’s constitutional court for the cancelation of the law providing for Germany’s contribution to the Mechanism. The court convened in 12 September 2012. Many international news channels broadcasted the hearing live. The decision of the court was relieving for the markets as it dismissed the rejections against the European Stability Mechanism. But the court stipulated two conditions for the European Stability Mechanism to be signed into a law: before the signing by the president, Germany’s related liabilities shall be capped and the Stability Mechanism, which will otherwise operate independently, will not have the mandate to change this limit.

Let me skip the conditions at this point and switch to the real source of the relief of the markets in the fall of 2012: the European Central Bank (ECB) had announced that it would purchase the sovereign bonds of up to 3-year maturity of troubled economies. But the ECB had imposed a condition: the countries first had to apply for the European Financial Stability Fund or the European Stability Mechanism if becomes operable as per the decision of Germany’s constitutional court on 12 September 2012. The ECB did not announce a limit for the purchases and agreed to purchase bonds as long as it considered borrowing limits high provided that the crisis countries agreed to fulfill the conditions for macroeconomic stability. This was indeed a strong guarantee mechanism. Following the ECB’s declaration, interest rates in troubled countries such as Italy and Spain decreased considerably before any purchase was made by the ECB.

Germany’s constitutional court has another case to see nowadays. This time it is about the ECB’s bond buying program that has no purchase limit. The hearing will potentially be a top item on the financial markets’ radar in the coming days. The previous judgment of the court about the funding limit is worth noting. In the event that the funds bestowed to financially troubled counties become nonperforming, the risk that a given country will face is limited to its contribution to the fund. But technically, there is no limit to the amount of funds that a central bank can grant (in form of purchasing sovereign funds of a country). The court, taking into consideration the loss the ECB will face in the event of nonperforming loans, might take a decision that will indirectly constrain the ECB in its actions. Evidently such decision would have a wide array of consequences. We will wait and see...

Note: If you are interested, please see for a detailed analysis Hans-Werner Sinn’s article dated 25 June on www.project-syndicate.org.

This commentary was published in Radikal daily on 29.06.2013