At its December meeting, the Governing Council wants to decide on the future structure of the bond purchases. This will also concern the purchase limits that have previously been in force in the PSPP (Public Sector Purchase Program). ECB President Christine Lagarde indicated in September that these limits could fall.
So far, the ECB has committed itself to the fact that the central banks of the euro system within the framework of the PSPP purchase a maximum of one third of each issue (“emission limit”) and a maximum of one third of all bonds from a public body (“issuer limit”). These limits do not apply to the PEPP (Pandemic Emergency Purchase Program) crisis program launched during the corona pandemic.
The question now is whether these emergency easing should also be extended to the PSPP and thus apply in the long term. What at first glance looks like an unimportant technocratic decision is, on closer inspection, a significant setting of the course for the future of the euro zone. This becomes clear when one considers the purpose of these upper limits.
The limit of one third results from the procedural rules for the case when a euro country gets into over-indebtedness and has to negotiate a haircut with its creditors. All euro countries have been obliged by the Treaty on the European Stability Mechanism since 2013 to include so-called Collective Action Clauses in the terms of their bonds.
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These clauses determine, among other things, the majorities with which a debt haircut is voted in a creditors’ meeting. The necessary majority is fixed at two thirds. Every investor who unites a third plus one euro of all bonds in a creditors’ meeting therefore has a right of veto.
The ECB should not become a strategic investor
With the purchase caps of a third, the Governing Council expressly wanted to ensure that the ECB would never become a strategic investor at a creditors’ meeting who would have to decide on a haircut. Exactly this motive was emphasized by the Governing Council in its update of the PSPP rules on the eve of the pandemic in February 2020. This decision of the Governing Council states: “In order to avoid … an obstacle to orderly rescheduling, thresholds will apply to the purchase of these securities by the central banks of the euro system.”
Just six weeks after this statement, the ECB Council then, in March 2020, with the suspension of the rules for the PEPP in the acute crisis, gave itself more room for maneuver with easily understandable arguments. However, it was always clear that the PEPP is only a temporary crisis instrument for an exceptional emergency. With the inevitable end of PEPP after the pandemic, bond purchases will then only be possible in the PSPP, in which the aforementioned upper purchase limits of one third continue to apply.
Empirically, the current situation is such that the euro system already owns more than a third of all government bonds in circulation in a number of countries through both purchase programs. For Italy, with its very high national debt, the stocks are currently just under a third according to bank calculations.
Exceeding this is not a violation of the euro system’s own rules, because the PEPP stocks are not counted towards the limits of the PSPP. However, these internal ECB rules are irrelevant for the external legal effect. For the voting rights of the ECB in a creditors’ meeting, it is irrelevant in which program the euro system acquired the bonds. De facto, the ECB Council has therefore thwarted the sense of the rules for the PSPP by relaxing the rules in the PEPP.
The caps are critical
Despite the fact that the target has been exceeded, it makes a considerable difference for the future of the euro zone whether the purchase limits for the PSPP continue to apply or not. After the end of the program, the PEPP stocks will at best be reduced slowly. However, given the rapidly increasing national debt, there is a prospect that the old PEPP portfolios will lose importance over time.
If the old rules were to remain for the PSPP, there would be a chance that the euro system could lose the blocking minority in the creditors’ meetings in the long run or that for some countries it would not even get into this difficult situation in the first place.
If, on the other hand, the upper limits for the PSPP also no longer apply, then the ECB would position itself as a strategic investor with full veto rights for an indefinite period of time. The consequences would be large. It is hard to imagine that the ECB representative would agree to a haircut in a creditors’ meeting.
According to the prevailing legal assessment, which is also based on the rulings of the European Court of Justice and the Federal Constitutional Court on the bond purchases and the Greek debt rescheduling, an ECB approval of a haircut at the expense of the central banks would have to be classified as monetary state financing. For these, the prohibition of Article 123 TFEU of the Treaty on the Functioning of the European Union applies.
Greece’s haircut is the precedent
Another detail is crucial: In the only previous precedent of the Greek haircut of 2012, the bond holdings of the euro system were excluded from the debt waiver. Such privileged treatment of the ECB is no longer possible for the PSPP and PEPP stocks.
The Governing Council has given the capital markets legally binding assurances that the demands of the euro system may not be given priority. This declaration of equality (“pari passu clause”) was necessary from the ECB’s point of view in order to prevent the bonds remaining in private hands from becoming high-risk papers that would have to bear the entire burden of a haircut in the event of a sovereign default.
All of this means that the abandonment of the ceilings will permanently block the path to debt restructuring for the PSPP. If there are further cases to Greece in the future in which the national debt of euro countries is no longer sustainable, then transfers would remain the only remaining solution.
These can be transfers from other member states, the EU or even a never-ending financing through ECB bond purchases. The old Maastricht order would then be eliminated in several ways. The unlimited bond purchases would further blur the lines between monetary and fiscal policy.
Is the euro liability community coming?
The no-bailout clause, which stipulates that each country is responsible for its debts, would be repealed. This would also put the Maastricht principle of market discipline aside, which relies on the self-interest of private investors in limiting national debt. Every private investor would know in the future that euro government bonds can no longer default, no matter how highly indebted countries are. Such a country receives any credit it wants on the market.
The ECB will therefore not decide on a technical detail in December, but ultimately on the permanent establishment of a euro liability community. It is remarkable what far-reaching constitutional decisions central bankers in Europe have to make today.
The author: Friedrich Heinemann heads the corporate taxation and public finance research department at ZEW – Leibniz Center for European Economic Research and teaches economics at Heidelberg University.
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