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A party in Europe, but a hangover is coming

September 12, 2012: 10:35 AM ET

The German court's ruling that the European bailouts can go ahead came with some major caveats. The euro hasn't necessarily been saved.

By Cyrus Sanati

angela-merkel

German Chancellor Angela Merkel

FORTUNE -- The euro will live another day, but it remains on life support. The markets rallied overnight on word that the German constitutional court had affirmed the Fatherland's role in the European bailout scheme, allowing the European Central Bank to heat up the printing presses. That was followed by reports that pro-euro parties were in the lead in a critical national election in the Netherlands, putting an end to concerns that one of the eurozone's strongest members could fly the coop.

But while the twin victories for the euro are worth popping a bottle of champagne, it isn't enough to open an entire case. There were plenty of caveats in the German ruling that could cause some problems for the bailout down the road. And while the court gave the thumbs up to the bailout, they seem to have expressed some severe reservations to Germany's role in a possible fiscal union with its eurozone partners.

This morning, traders across Europe nervously waited the decision by Germany's highest court as to whether or not the eurozone's largest member would remain its biggest booster. The court was considering whether or not it was legal for Germany to participate in the various eurozone bailout schemes, most notably the proposed 700 billion euro European Stability Mechanism. Those that oppose the bailouts believed that Germany had given up too much of its sovereignty to Europe and that the decisions made by their politicians to support the bailout circumvented German democracy. A "no" ruling would have been disastrous for the euro as it would have meant a German withdrawal from the bailouts, which some observers believed would be the final nail in the coffin for the common currency.

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But that didn't happen. The court ruled that the claims by the petitioners were largely unfounded and that the pro-European slant to the German constitution permitted the nation's leaders to work together with their European partners to stabilize the continent as need be. That means that Germany could indeed participate in the bailouts and other future pan-European pacts. This is critical not just for financing the direct payments needed for eurozone stragglers, like Greece, but also for the European Central Bank's plan to buy bonds in the secondary market to keep big nations, like Spain and Italy, from collapsing. That's because the initial chunk of money needed to get that program off the ground will be financed, initially, by the bailouts.

This was largely good news for euro boosters in Germany. Chancellor Angela Merkel cheered the ruling in a speech before the German Parliament, noting that the courts had sent a strong signal of confidence in the common currency as well as Germany's role in steering the continent back on course.

But the court's ruling came with some caveats that could cause some future delays in the eurozone rescue. Most notable is that they capped the amount of German participation in the ESM to 190 billion euros. Why such an exact number? Well, 190 billion equates to 28% of the ESM, which is roughly the same percentage of Germany's GDP relative to the combined GDP of the eurozone. In essence, the court seems to be saying here that Germany should only pay its fair share – no more. That could become a problem as some of the largest nations in the eurozone, like Italy and Spain, also happen to be the ones that need the most help.

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Luckily for euro boosters, the court gave the government some leeway. If Germany needs to contribute more money, which it probably will, the court said it could, but it would need to be approved by the German parliament. While this won't be a problem on the front end of the bailout, it could possibly prove at least a minor impediment once the fund burns through the first 500 or 600 billion euros. The German parliament has largely pushed aside partisan differences and come together during the crisis. But this camaraderie could breakdown in the coming months as the German federal election, scheduled for next fall, draws closer.

So from the ruling it is clear that the bailouts, as well as the ECB's bond buying scheme announced last week, known as OMT, can proceed. So is the euro saved? Well, it has been thrown a life preserver, but it can still drown before it gets to shore. Both the ECM and the OMT are emergency measures and are far from being permanent fixes to the crisis. Their role is to calm the situation and reduce volatility just enough to allow eurozone leaders time to design a more comprehensive and long-lasting solution to the crisis, namely, a strong fiscal union. Such a union can only come to fruition, though, if all eurozone parliaments voluntarily agree to give up their budgetary powers to a central European authority, such as they gave up their monetary powers to the ECB on the founding of the euro.  That's going to be the toughest obstacle to overcome in this crisis. Indeed, all the delays up to this point were arguably due to eurozone leaders' unwillingness to face up to this reality.

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This is where it all gets tricky. While the court affirmed the government's ability to participate in the bailouts and bond buying (the emergency measures),  it also put the government on notice that a fiscal compact of any sort (the long-term solution), may not be possible given the way the German constitution is written. Buried in the opinion, which, frankly, most people won't read, is this little gem:

"As elected representatives of the people, the Members of the German Bundestag must retain control of fundamental budgetary decisions even in a system of intergovernmental governing."

This statement seems to put the German parliament (Bundestag) on notice that it can agree to a lot of stuff, but when it comes to the power of the purse, that's something that must remain in Berlin. This means a fiscal compact may only be possible if Germany changes its constitution. That would require a national referendum, something that might be difficult to attain given how upset the German people have become lately with the whole eurozone experiment.

It is now time for Angela Merkel to start selling the idea of a fiscal compact so that, if necessary, she can have the power to move forward with a possible referendum. When the German people vote in favor of that, only then can Europe truly celebrate.

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