By Marshall Auerback, a hedge fund manager and portfolio strategist. Cross posted from New Economic Perspectives
Hans-Werner Sinn, president of Germany’s Ifo Institute and the director of the Center for Economic Studies at the University of Munich, has taken to the pages of the NY Times to explain why Berlin is balking on a further bailout for Europe. Amongst the points that Sinn makes against German sharing in the debt of the euro zone’s southern nations is a legal one:
For one thing, such a bailout is illegal under the Maastricht Treaty, which governs the euro zone. Because the treaty is law in each member state, a bailout would be rejected by Germany’s Constitutional Court.
Sinn also argues that Germany’s counterparty credit exposure already exposes the country to immense credit risk:
Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion. Should the euro fail, Germany would lose over $1.35 trillion, more than 40 percent of its G.D.P.
Let’s leave aside Sinn’s broader rhetorical points (“Has the United States ever incurred a similar risk for helping other countries?” Umm, yes, it did – there was that little matter of World War II). Levity aside, professor Sinn does raise a huge potential conundrum as far as Germany and its broader relationship to the Eurozone’s institutions go. In fact, recent German Constitutional Court rulings on bailouts could well blow apart the European Monetary Union. This is because the potential unlimited liabilities to which Germany is exposed under Target 2, the ELA, and various other lender of last resort facilities adopted by the European Central Bank do on the face of it run afoul of the court’s ruling, which argued that any future bailouts had to be limited and subject to the democratic consent of Germany’s Parliament. What happens, for example, if someone in Germany were to challenge the very legality of Target 2 on those grounds?
This is not the first time in which Sinn has expressed concerns in regard to Germany’s exposure via “Target 2”; indeed, he was to our knowledge one of the first to raise this issue in a number of scholarly papers (see here).
So what exactly is “Target 2”? Target 2 refers to Trans-European Automated Real-time Gross Settlement Express Transfer. It is the euro system’s operational tool through which the national central banks of member states provide payment and settlement services for intra/euro area transactions. Target 2 claims can arise from trade and current account transactions as well as from purely financial transactions.
Recently financial transactions have become dominant. Funds have been taken out of banks on Europe’s periphery and have been deposited in banks in the north of Europe, principally in Germany. The bank receiving the deposit places those funds with the Bundesbank (or other recipient national central banks); in doing so it has its funds delivered through the Bundesbank (or other recipient national central banks), which in turn deposits with the ECB. Via the ECB the funds then go to the bank on the periphery that has lost deposit funds. That is a Target 2 transaction. The so-called Target 2 outstanding balance is the net position of such claims between two European countries. The ECB in effect acts as the hub through which these transactions are mediated.
Target 2 has taken on heightened relevance in the past year as a consequence of the Eurozone’s silent bank run. As deposits have fled the periphery banks – Greece, Portugal, Ireland and Spain – these banks have become increasingly reliant on Target 2 to overcome funding problems.
As an aside, it is also worth noting that banks can also borrow under the emergency liquidity assistance (ELA) program. Such assistance is extended by single national central banks to their banking systems. The risk is borne at the national level. The collateral requirements imposed upon a commercial bank for obtaining ELA funds is less than the collateral requirements needed for obtaining Target 2 funds. The national central bank in a country like Greece with commercial bank deposit runs ultimately funds its ELA financial assistance to its commercial banks from the ECB. That ECB funding for ELA is above and beyond Target 2 funding.
The ECB also conducts repo operations with banks in the system. Recently these repo operations (e.g., LTRO’s) have also been funding banks in the periphery that have been experiencing deposit runs. It has been widely believed that LTRO funds received by Italian and Spanish banks went entirely into purchases of their government’s bonds. Some of these funds did go into purchases of national government bonds, but only in part; some of those LTRO funds financed deposit losses.
So where is the money ultimately coming from? To some extent there is a circular quality attendant with the banking crisis. Money leaves, say, a Greek bank. A wealthy Greek ship-owner is worried about the solvency of his country (or a concern that he might actually have to pay taxes), so he quickly withdraws the sums from a Greek bank and redeposits the money with a German bank. The German bank now might find itself flush with billions of euros which it can’t use, so it re-deposits the money with the Bundesbank, which in turn places it with the ECB. The ECB then might turn around and extends funding (via Target 2, or the ELA) back to the Greek banks and in effect closes the financial circuit created in the Eurozone when a citizen of one country chooses to move his deposit from a domestic bank to a bank domiciled in another euro area nation.
Of course, some of this money goes outside the euro zone (Swiss banks, US banks, London property, gold, etc) and it is almost certainly the case (even though the ECB would never admit it) that some of this funding (perhaps most of it) comes the ECB actually creating new net financial assets. To get a sense of how big the ECB’s exposure is, it is worthwhile looking at its “loans to other monetary financial institutions”, which is one of the line items buried in its balance sheet. That the ECB creates new euros in itself is hardly problematic from an operational standpoint: as the sole issuer of the euro, the ECB is free to provide as many euros as is needed to keep the funding system in place. It cannot go broke.
To reiterate, a private bank needs capital – clearly because there are prudential regulations requiring that – but because it can become insolvent. It has not currency-issuing capacity in its own right. While the ECB has an elaborate formula for determining how capital is from the national member banks, at an intrinsic level, it has no need for capital. It could operate forever with a balance sheet that if held by a private bank would signal insolvency.
The point is that there are no comparable concepts for a currency issuer and a currency user in terms of solvency. The latter is always at risk of insolvency, the former never, so there is no OPERATIONAL risk or limit per se implied in the ECB’s actions.
Although it might well assert to the contrary, the ECB has massively expanded its lender of last resort facilities, in many cases in violation of the Maastricht Treaty. As Professor Wilhem Buiter has argued in a recent paper:
[T]he European Central Bank (ECB) has been acting as lender of last resort (LoLR) for the sovereigns of the Eurosystem since it first started its outright purchases of euro area (EA) periphery sovereign debt under the Securities Markets Programme (SMP) in May 2010 (see de Grauwe (2011b), Wyplosz (2011, 2012) and Buiter and Rahbari (2012a)). The scale of its interventions as LoLR for sovereigns has grown steadily since then and its range of instruments has expanded. We interpret the longer-term refinancing operations (LTROs) of December 2011 and February 2012 as being as much about acting, indirectly, as LoLR for the Spanish and Italian sovereigns by facilitating the purchase of their debt by domestic banks in the primary issue markets, as about dealing with a liquidity crunch for EA banks. A future third LoLR instrument will be indirect lending by the Eurosystem to periphery sovereigns. This will be achieved through national Central Banks lending to the International Monetary Fund (IMF) and the IMF lending to the Spanish and Italian sovereigns, once these sovereigns have come under suitable troika (IMF, European Commission and ECB) programmes. If and when the European Stability Mechanism (ESM) gets a banking licence (becomes an eligible counterparty of the Eurosystem for the purpose of repos or other forms of collateralized borrowing), the ECB will have a fourth mechanism through which it can act as LoLR for sovereigns.
Which gets us back to the issues raised by Sinn: Reflecting mounting German concerns about the country’s growing counterparty exposure risks to the periphery, Sinn has proposed limiting Germany’s Target 2 exposures. From a German legal perspective, Sinn is on very solid ground. In May 2010, when Germany’s Parliament voted to provide financial aid to Greece to prevent it from insolvency and to approve the €440 billion ($620 billion) European Financial Stability Facility, with €147 billion in loan guarantees, this was challenged in Germany’s Constitutional Court. At the time, Germany’s highest court ruled that the parliamentary criteria had been adhered to when the government agreed to those specific bailout measures.
At the same time, the court said the Bundestag had not ceded any of its authority in budget decision-making with its approval of the legislation. Furthermore, the judges ruled that future aid package resolutions could not be automatic and should not infringe on the future decision-making rights of Germany’s parliament. Aid packages, they argued, would have to be clearly defined, and members of parliament would have to be given the opportunity to review the aid and also stop it if needed.
Under the terms of the German court’s ruling, then, Target 2 itself would appear to be unconstitutional, even though Target 2 itself was one of the features incorporated in the Treaty of Maastricht. But the problem with Target 2 is that it involves an open ended indeterminate exposure of the German people to losses involved in the bailout of the periphery. The German parliament has no say in the disbursements. That this is unconstitutional would appear to be very clear on the basis of Germany’s Constitutional Court rulings. Logically, it should extend to the other Lender of Last Resort financings that have been undertaken by the ECB, cited in the Buiter article above.
So consider the following: imagine that there is a Constitutional Court challenge of the Target 2 and other ECB lender of last resort financings. The day this occurs and becomes public the bank run will accelerate greatly. To be sure, the court might well rule that ECB agreements amongst the member states take precedence over the earlier ruling expressed in the wake of the 2010 bailout for Greece. But it would be hard to square that argument with the clear meaning expressed by the German court at that time. And if the Constitutional Court rules that ECB lender of last resort bailouts are unconstitutional the banks on the periphery will have to close and suspend payment on requests for withdrawals. So Germany’s court could well become the instrument of the euro’s destruction by frustrating the ECB’s capacity to operate as lender of last resort.
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As for the Target2 imbalances, Kantoos wrote a very interesting remark:
“Collateral is provided for almost all these transactions as they originate in money creation by the central banks. If Greece leaves, and wants to steal the collateral, the euros in German bank accounts of Greek citizens and companies will probably be converted by force into drachme, which makes the “losses” of the ECB go away. If Greece hands over the collateral, well, then we don’t know how much will be lost.”
But that would not be very “legal”, wouldn´t it ?
And what do you do about the Greek Euro deposits in London where the Oligarchy of that country resides ? Please no “Luftwaffe”-jokes ……..
Don’t know if it would be legal, this would have to be judged by international and national cours.
But I guess it would be a perfectly justified act of self-defense of the eurozone creditor nations against being robbed by the leaving nation(s – Greece is just an example).
As for the Greek cleptocrat elite’s Euro deposits outside the eurozone – the UK, USA, Switzerland and so on would have to find their own solutions.
That was a point I made about half a year ago to one of PP articles. Of course, the big question is whether the collateral is any better than a dead cat (say I’d expect that lots of the collateral would be Hellenic bonds or ASBs backed by assets in Greece, thus hard to enforce unless you want to declare war) – which still may mean that redenomination of assets base on the domicile of holder would be best solution (in fact, I’d argue that EMU should move to redenominating everything to currency-of-domicile at a fixed rate, as that would allow internal devaluations. Then you can institute external capital controls – which would be allowable under EU law, and necessary for his to work – to avoid the worst of speculation. It may still not work, but would work better than the bailouts).
Moreover, if it was widely known, it may have an effect of detterent at least short term on the bank runs in Greece/Spain etc. Moving your money to an EU bank is effectively cost-free, moving your money to say UK or US bank is not.
Don’t worry about Target2
http://blogs.reuters.com/felix-salmon
The German Constitutional Court will not rule against the will of the German political class – it has proven that whom they serve. Though it provides a nice negotiation argument for Merkel in her bluff.
Germany has only two bad choices: Either bleed dry via Target 2, ELA, ECB Bad Bank or agree to some form of Joint Liability (with or without “Maastricht promises does not matter as those promises are never kept anyway ….).
More choice was there in the GFC in 2008, 2010 when French banks stuffed their Greek bonds into the ECB.
Now there is capital flight and those balances are rising day by day making it even more expensive by the day.
The German political class does not want to spoil the Euro-Illusion. They do not have a Plan B.
Italy, Spain, Portugal, Greece, even France – they all have one: Drop out / default (again) and stick the bill to remaining creditors ECB, ESM, EFSF.
It is only seventy-two years since Germany last blew Europe apart. Is it progress that they will be doing it this time with lawyers and judges? The whole thing is so idiotic. There is far too much money in the hands of too few. The few are so frightened of losing any of it that they persistently operate to prevent others from having any. It is this persistent fright inspired stupidity that creates the deflation which sweeps away all asset values and makes trade impossible. The same thing happened in 1930. It is as though Keynes never lived and nobody alive has read his book. Listen, you id**ts: print money, drop it from helicopters if you must, but try to spread it evenly this time. Try to imagine what would have happened if in 2008 the Treasury sent every taxpayer $100,000. Who would have cared if the banks went into liquidation? The Fed could have preserved its balance sheet and money today might actually been worth something.
make that ‘money today might actually be worth something.’
Isn’t Steve Keen recommending that helicopter drop to the People right now?
A little too late. Our economy has been parmanently destroyed: the mighty dollar is no longer the world currency and it will be worth nothing in a very short time. We’d be better off with banks and their assets (Ha Ha Ha! Good one! Their “virtual” assets) being seized and all loans written off. That wouldn’t require printing of more money.
Money “printing” (for a universal bailout) could be done without debasing the currency IF it was combined with a ban on further credit creation and metered to just replace existing credit as it is paid off.
The case referred to here was decided on narrow grounds.
The week after the ruling Germany’s chief justice made it crystal clear in a newspaper interview that permanent transfers of German taxpayer funds cannot be authorised under the existing constitution, even if parliament wishes it so.
His point? To provide for the necessary transfers Germany needs a new constitution. And that requires a referendum. (Federal referendums are not possible, and parliament is the mechanism to amend the German constitution – but this is not about amending, it’s about a new constitution.)
A couple of weeks ago an anonymous German civil servant stated that such a referendum is currently unwinnable. So it’s not even on the horizon.
I feel Germany will wait until the €zone has been pared down to a manageable size.
Hubert,
dont you think that is a little naive, that Spain or Italy could just default on their ECB debt, and that would have no consequences.
Merkel says: if the Euro fails, Europe fails.
Sarazin says: Europe does not need the Euro.
I am 50:50
I think it is probably better, that all countries that can not / want not live with the Maastricht treaty, leave the Euro, which has to be negotiated / down outside non-existing rules.
If the whole EU bureaucracy blows up, it would open up the chance to rebuilt completely anew, after a few years, leave out folks like the UK and Greece and some others, and built it in a real democratic and acountable way, and in a way that is robust for conflicts.
That “fantastic object” used to be called a “chimera” didn’t it?
A common currency used by nations with disparate social agendas, trade and professional protections will never work. Due to these items as will as lack of a common language will also make labor less mobile. The Euro is a train wreck in slow motion.
Levity aside, did the Marshall Plan amount to 40% of the GDP of the USA?
my understanding is, that the marshall plan was in total about 3-4% of the german GDP at that time, for the rest of (western) europe more like 5-6%, and that it was for the US about 4 or 5% GDP, stretched over 4 – 5 years (1947 – 1952).
The numbers Sinn gave today on VoxEU are about 2/3 of mine.
But his point that Germany / EU gave Greece something like 50 – 100 marshall plans, is certainly worth to mention.
Germany hasn’t given Greece any money at all.
Germany has given money to the *German banks* which hold Greek bonds. It’s not the same thing.
If the German money had gone directly to actual productive activity in Greece, the way the Marshall Plan did, Greece would be booming.
Also, if the Marshall Plan had consisted entirely of recapitalising the banks from Weimar Germany, Germany would still be a smoking ruin.
No, because the U.S. acted “in time.” This Germany failed to do, hence the “unintended consequences” of FAILURE (Aaargh!) to bite the bullet in time (when it was but one bullet).
Besides, do we not behold in the “German” populace today the DNA of “Hitler’s Willing Executioners” even as the EuroPrincely .01% (“Nobility”) today expresses the DNA of the “Rentier class” bailed out in the Versailles Treaty at the expense of the working stiffs, as Veblen understood so keenly?
German leaders invoke the law when they don’t want to do something, and don’t when they do. Sounds like a pretty typical response for a kleptocracy.
There are broader political and sociological implications to the MMT analysis of the financial/economic crisis in both Europe and the United States.
The professional academics who have been primarily involved in the creation and expansion of the MMT perspective seem to be attempting to strengthen (under the guise of simply offering a description of how a monetary sovereign actually operates, whether covertly through the ECB for the EU or overtly with the Federal Reserve in the U.S.)a rationale for a system of governance (which has slowly evolved in both Europe and the U.S. over the past 120 years) which shifts authority increasingly away from democratic accountability toward rule (particularly in the area of central banking and fiscal budgets) by expertise in particular schools of economic and legal thought.
In both the U.S. and Europe– these professional experts–(of different political persuasions using different forms of cultural capital) are attempting to create a public and private sphere made in their own image.
This process has helped to ignite a crisis of democratic legitimacy in both continents.
Really? I’d like to see your evidence for these claims.
Most MMTers appear to ME — perhaps I’m wrong — to be Greenbackers, who believe that the creation of money should be directly controlled by the elected government. This is exactly the opposite of what you complain about in the current system of government.
The MMTers accurately point out that *government* currently has exactly the powers they describe. They do not usually discuss the political issue: which is that the *elected* government have handed many of these powers over to a bizarre *unelected* portion of the government (The Federal Reserve, Bank of England, ECB, etc.) based on goofy neoclassical economic ideology and rattletrap nonsense about “central bank indepedence”.
I guess I’m saying that the MMTers seem to me to actually be on the side of democratic accountability — and I would expect them to agree with your analysis of the cause of the crisis of democratic legimitacy, caused partly by OTHER economists.
Sinn’s legal point seems dubious. The Maastricht Treaty does not comprehensively prohibit bailouts (nor does it say that if Greece left the Euro it would lose EU membership and all the other privileges that go with that). Depending on how a package is structured, it shouldn’t present any legal issues, unless the Germans want it to. In short, the legal issues are a fig leaf for the Germans to hide behind, not the real issue.
Nathanael
I’m not going to take the time right now to present my specific evidence for my fear that most of MMT will most likely end up on the wrong side of democratic accountability (especially if they were to some day be successful).
The more general framework for the claims that I am making about MMT assumes that there is a more pervasive logic of domination the pervades the modern structure of power in the U.S. Nearly all of the commentary on Naked Capitalism assumes (I believe incorrectly) that all conflicts can be defined in economic terms (variations of labor/capital conflict).
But what is consistently missed using this framework is the growing disparity of political power between the average citizen and the professional expert. This disparity of power evolved gradually but seem to have accelerated since WWII.
These experts and their cultural capital (mastery over a particular body of knowledge—with the proper credentials) in the fields of law, economics, finance, medicine, accounting etc.) have helped to create an administrative state that represents to as great an extent as possible their own interests (think as a symbol of this process 2,000 pg bills in Congress on health and financial “reform.”) rather than the interests of the general populace.
From my perspective, MMT, with their claims of superior knowledge, built on the foundation of a naive empiricism covers up their prescriptive lurch for power in this evolving administrative state—the attempt to replace the neo-classical crowd with a new and improved set of scholars–supposedly(as with the neoclassical crowd) simply looking after our interests!