Euro zone breathes again as German court backs bailout fund

BRUSSELS, Belgium — Eight middle-aged Germans in silk caps and scarlet robes may have just saved the world from financial meltdown.

The judges of Germany's constitutional court on Wednesday dismissed a legal complaint against Germany’s participation in the European Stability Mechanism, the $645 billion bailout fund that’s a cornerstone of plans to save the European currency.

Speaking at the same time, the European Commission president, Jose Manuel Barroso, issued an impassioned call for the EU to evolve into a “federation of nation states” as he unveiled plans for giving the European Central Bank sweeping new powers that would be the first step toward creating a fiscal union.

The German decision was crucial because the country would be the fund’s largest contributor. It prompted financial markets to rise and politicians to breathe a huge sigh of relief — even though the constitutional court imposed conditions on participation in the ESM, including parliamentary approval for increasing the $240 billion limit on Germany's contribution.

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The ruling is a blow to euro-skeptics who had argued the ESM would commit Germany to unlimited funding of indebted countries and a victory for Chancellor Angela Merkel, who said it was "a good day for Germany, and a good day for Europe.”

"Germany is accepting its responsibility as the largest economy and a reliable partner in Europe," she told the parliament in Berlin.

No one is pretending the euro zone is out of the woods. However, Wednesday's court ruling, coming a week after the European Central Bank agreed to use its immense financial firepower to buy up bonds of struggling countries, suggests Europe's policymakers may finally be getting their financial ducks in a row.

As the judges were reading their verdict in the university town of Karlsruhe, a few miles away in the French city of Strasbourg, the European Commission unveiled a long-awaited package of measures to prevent Europe's banks from repeating the mistakes that dragged countries such as Spain and Ireland into crisis.

The proposals for a so-called banking union would give the European Central Bank the power to supervise the more than 6,000 banks in the European Union. The ECB would eventually be able to bail out or shut down failing banks and set up a Europe-wide fund to guarantee citizens' savings.

Barroso said the new system “would restore confidence in the supervision of all banks in the euro area."

“In future, bankers' losses should no longer become the people's debt, putting into doubt the financial stability of whole countries," he added.

However, the plans need backing from EU governments and banking heavyweights Britain and Germany have already signaled their reservations.

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The euro zone's rare run of good news continued later on Wednesday when exit polls from parliamentary elections in the Netherlands showed a surge in support for centrist parties that broadly support plans to save the euro zone. They predicted the center-right party of Prime Minister Mark Rutte would win  41 seats in the 150-seat parliament, followed by the Labor Party with 40. A far-right party that had campaigned for a Dutch exit from the euro is on course to lose almost half its seats.

However, more hurdles loom for solving the euro crisis, including pending legal challenges to other aspects of the EU's save-the-euro strategy on which the German constitutional court will have to rule again.

Spain is also under pressure to decide whether to bite the bullet and ask the ECB to start buying up its bonds. Although that would stave off economic collapse by bringing down the government’s high borrowing costs, it would force Madrid to agree to international supervision of its finances.

Speaking ahead of a meeting of EU finance ministers on Friday, Prime Minister Mariano Rajoy told Finnish media that any decisions on austerity measures linked to ECB aid would be made by his government alone.

He also said he’s “ruled out” asking for a bailout for the entire country.

The pressure on the Spanish government was starkly evident on Tuesday, when more than a million protesters filled the streets of Barcelona to demand independence for their Catalonia region and blame the central government for the crisis.

There were also protests on Wednesday in Greece, where the government is struggling to convince international lenders that its latest $15 billion in budget cuts are enough to free up the next $40 billion slice of bailout money it needs next month to stay solvent.

Europe's continued failure to trigger economic recovery looms over the various financial puzzle pieces. The euro zone as a whole is close to slipping into recession, and there’s little sign of a turnaround. Policymakers know there’s little chance bond buy-ups and bailout funds will erase doubts about the euro's future until the economy starts working again.

"We need growth, sustainable growth," Barroso told the European Parliament during his call for closer political union. "Growth is the lifeblood of our European social market model: it creates jobs and supports our standard of living. But we can only maintain growth if we are more competitive."

The head of the EU's executive body used his State of the Union speech to urge southern European nations to push ahead with painful economic reforms to improve competitiveness, and tell Germany, the Netherlands and other more stable economies to be more supportive.

Barroso said an eventual EU federation is necessary for tackling the crisis and maintaining Europe's place in the world.

That’s for the longer term, and would require a change to the EU treaty. In the meantime, Wednesday’s German court ruling allowed Luxembourg's Jean-Claude Juncker, who chairs meetings of euro zone finance ministers, to call the first meeting of the ESM’s board for Oct. 8, a sign European authorities want to move fast to activate their anti-crisis tools.

Although the conditions imposed by the German court may limit the fund’s future flexibility, analysts said they were widely expected and will not prevent the ESM from starting work.

"The Karlsruhe decision on the ESM preserves the status quo, more or less, and is the best possible outcome given the circumstances!" tweeted Sony Kapoor, managing director of the think tank Re-Define. "But growth prospects have never been worse and political space is shrinking."