Opening the Umbrella: ESM Permanent Bailout Fund Prepares for Prime Time

By Sven Böll, Martin Hesse and Christian Reiermann

The court battle against the permanent euro bailout fund, the ESM, has become the largest in German legal history. Yet despite widespread concerns, fund head Klaus Regling is preparing for action. The most important question surrounding the fund, however, remains to be answered: Will it work?

Photo Gallery: ESM on the Eve of Activation Photos
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Stacks of paper make it impossible to get an unobstructed view of the Balinese island paradise. For the past two years, this idyllic scene carved in wood has been propped up on a sideboard in a Luxembourg office. The picture's owner hasn't found time to hang it on the wall. Instead, he has allowed it to gradually become submerged under a sea of documents.

The office belongs to Klaus Regling, head of the European Financial Stability Facility (EFSF), the temporary euro backstop fund. He brought the picture back from Indonesia over 20 years ago, when he did a stint there for the International Monetary Fund (IMF). It has long since morphed from a souvenir to a symbol of the crisis. The message is "look here, we don't have any time for trivialities" and "our work environment is just as temporary as the rescue fund."

Perhaps the wooden picture will soon get a respectable, permanent location. Regling and his team are preparing to move a few blocks down the street, part of the plan to turn a stopgap measure into an enduring one. The temporary EFSF rescue fund is about to give way to its permanent successor institution, the European Stability Mechanism (ESM).

Before that can happen, though, the ESM must still clear some legal hurdles. On Sept. 12, the German Constitutional Court will rule on lawsuits seeking to prevent the government of German Chancellor Angela Merkel from participating in the new bailout fund with its €700 billion ($880 billion) firewall.

Some 37,000 Germans have joined the complaint, making it the largest such case in the history of the court. Most prominently, however, the list of plaintiffs includes Peter Gauweiler, a politician with the Christian Social Union, the Bavarian sister party to Merkel's Christian Democratic Union (CDU), former Justice Minister Herta Däubler-Gmelin of the center-left opposition Social Democrats (SPD), and a group of professors led by economist Wilhelm Hankel, a prominent critic of the euro. They all fear that joining the rescue fund necessarily means that Germany's parliament would lose its constitutionally guaranteed right to oversee the budget.

Even More Uncertain

If the critics win, the provisional measures to bolster the euro could give way to widespread panic, with frenzied markets and frantic politicians. The instrument designed to guarantee stability in the euro zone could end up sparking renewed turbulence. The flight from the euro would accelerate, the sovereign bonds of financially weak countries that have just managed to stage a slight recovery would once again come under pressure, and the future of the euro would be even more uncertain.

Given the consequences, it is doubtful that the court will prevent Germany from contributing to the ESM -- but there are likely to be a few conditions.

Regling refrains from making any comment on the outcome of the trial. He wants to avoid the impression that he is putting the judges in Karlsruhe under pressure. All he will say is: "Without Germany, the ESM is pointless."

The EFSF head has decided to proceed as though everything were going according to plan, choosing to ignore the lawsuits and the looming verdict. There is, after all, plenty to do, including hiring new staff to expand the workforce from 57 to 75 employees by the end of the year and establishing a new website. A new logo has already been created.

Making the transition from a special-purpose entity under Luxembourg law to an international financial institution presents him with totally new challenges that have nothing to do with the euro. The ESM intends to establish its own health insurance plan, and it needs a pension fund.

Insurance Office?

But much will remain the same, including the bailout fund's mission -- that of providing cash-strapped member states with fresh money in exchange for strict austerity measures. The instruments at the ESM's disposal will also be unchanged, as will the salaries earned by its staff. Regling will continue to make over €300,000 a year.

As the EFSF transforms into the ESM, it seems less like a power-hungry Moloch and more like a branch office of a liability insurance company that calmly sorts its claims. There's no recognizable sign of frantic rushing or nail-biting. The trading department staff watches brightly-colored curves on flat-screen monitors showing the exchange rate of the euro and yields on sovereign bonds. Many employees come from Brussels institutions, such as the European Commission. But the European Investment Bank (EIB) has also sent staff here, as has the European Central Bank (ECB) in Frankfurt.

One of Regling's staff members is Andres Sutt, 44, an economist from Estonia who worked at his country's central bank and most recently represented his country at the International Monetary Fund. Throughout his professional career, he has done nothing but combat the economic turbulence that has shaken his country again and again. "It will take time before trust in the crisis countries returns, but it will return," says the Estonian, as he summarizes his experience.

Estonia has proven that drastic remedies, such as those prescribed for Greece, are effective. Three years ago, the Estonian government slashed its budget and reduced salaries and pensions because its economy was drastically shrinking. At the same time, it maintained a steady exchange rate with the euro and became a member of the monetary union at the beginning of 2011. "It's naïve to believe that emerging from the crisis will be painless," says Sutt.

Regling is convinced that the euro rescue is on the right track. He says that competitiveness has increased in Ireland, Greece, Portugal, Spain and Italy. Their current account deficits are improving. The countries in the program have made progress instituting the necessary changes, and they have done so "on a massive scale." Regling attributes part of this success to himself and his team. "If it wasn't for us," he says. "Portugal and Ireland would probably no longer be in the euro zone."

Gigantic Bad Bank

Yet despite all these efforts, the euro crisis has spread, making it necessary to follow up the temporary rescue fund with a permanent one.

But that's far from enough for many critics, primarily those from the southern regions of the monetary union. Politicians such as Italian Prime Minister Mario Monti and his counterparts from Spain and France, backed by the IMF, regularly call for the rescue fund to be doubled. They would like to grant the ESM a banking license so it could borrow unlimited amounts of money from the European Central Bank.

Other critics, primarily in northern Europe, say that the ESM already has too much power. They see the rescue fund as a gigantic bad bank and yet another step toward a debt union.

"The ESM undermines the foundation of the European monetary union," says Helmut Siekmann, a professor of monetary, currency and central bank law at Frankfurt University. He says the rescue fund violates the ban on forcing other euro member states to assume liability for the financial obligations of debt-ridden countries.

Siekmann even suspects that the treaty contains a loophole that could raise the upper limit of Germany's liability beyond the legal ceiling of €190 billion. He says that Regling's fund could in fact mobilize more than the €700 billion that has been authorized once it has received the paid-in capital amounting to €80 billion. The only precondition would be a unanimous agreement from the ESM Board of Governors, which includes the finance ministers of euro-zone member states. The fund could then, theoretically, collect unlimited amounts of capital.

Any one of the ministers on the board could veto such a decision, including German Finance Minister Wolfgang Schäuble. "But will he have the backbone to vote no when everyone else is in favor?" asks Siekmann. The legal expert explains that even if Schäuble abstains, according to the treaty, it would be counted as a vote in favor. "That's unusual when a unanimous decision is required," criticizes Siekmann, "and it's problematic."

'Doesn't Make Sense'

Nevertheless, says the professor, the Bundestag, Germany's parliament, would also have to give its assent if an increase in firepower for the ESM were approved in a rush. "But even without parliament's approval," he says, "Germany would be bound by international law to pay the amount approved on the ESM Board of Governors." This, argues Siekmann, "undermines the democratic process."

Indignation isn't just limited to academic circles, but can also be heard in Germany's rural heartland, such as in a dimly lit conference room of the CCH City Club Hotel in the northern city of Oldenburg. A group called the Free Voters has staged an event called "Stop the Euro Rescue Fund" that has attracted a large number of pensioners. The most prominent speaker is Stephan Werhahn, 59, who embodies the hopes of many ESM opponents.

The financial expert, who is a grandson of Germany's first postwar chancellor, Konrad Adenauer, recently left the CDU and now intends to run as the Free Voters' top candidate in the 2013 Bundestag election. "We Germans pump billions of euros into heavily indebted banks in our southern neighbors, but at the same time have no money to renovate our own schools," he says. "That just doesn't make sense."

Werhahn rejects suggestions that he's a populist. Instead, he sees himself as a mouthpiece for the silent majority. "The monetary union won't survive in this form," he says. "The ESM is merely postponing the inevitable, not halting it."

Grumbling in Isolation

The anti-ESM movement includes organizations such as the Taxpayers' Association and initiatives that go by names such as the "Alliance of the Will of the People" and "Civil Coalition." They are all enjoying a surge in membership, but have little impact. This is partially because the groups are not networked; they are all grumbling in relative isolation.

ESM opponents have thus pinned their hopes on the German Constitutional Court. Werhahn is convinced that the country's top judges can come to no other conclusion than to stop the "700-billion monster." As he puts it, the rescue fund has "no democratic legitimization." He says that the amount of money that Germany has to pay to save the euro will in the future no longer be decided in Berlin but, rather, in Luxembourg.

Norbert Barthle, the CDU's budgetary policy spokesman in the Bundestag, is familiar with all of these arguments -- and he's tired of listening to them. He remains convinced that Germany's liability will not exceed €190 billion, as determined by the law.

"The critics overlook that there is no other area where the Bundestag has such extensive rights of co-determination as with the rescue fund," he says. Even Finance Minister Schäuble must consult the Bundestag before heading to Luxembourg. Lawmakers determine how much leeway Schäuble has in negotiations -- on the volume of an aid package, for example.

'Over in One to Two Years'

Even afterwards, nothing can happen without the Bundestag's approval. Once the Board of Governors has reached a decision, the parliamentarians have to approve the decision once again. Subsequently, the budget committee has to clear each payment tranche.

No other national parliament in the euro zone enjoys so much power. Of course, Barthle realizes that limits will be placed on this influence in the future. There will be situations in which the government makes an ad hoc decision, that parliament can only wave through -- provided that it doesn't want to bring down the chancellor. "But that will tend to be the exception, not the rule," says Barthle.

Meanwhile, ESM chief Regling is already looking ahead to the period after the crisis. When everything is over, he intends to place the ESM in something like a state of hibernation. Personnel and resources will then be greatly scaled back, with only an ESM skeleton crew on stand-by. If necessary, though, the organization could quickly be reactivated.

When will that time come? Regling, the eternal optimist, doesn't take long to answer. "If all the states in the monetary zone strictly adhere to their fiscal consolidation requirements and continuously improve their competitiveness, then the crisis can be overcome in one to two years," he says.

Unless, of course, ESM critics win their lawsuits.

Translated from the German by Paul Cohen

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