The German plan for a eurozone insolvency procedure has spooked the markets and drawn political fire. In this new CER briefing note, Katinka Barysch explains why Berlin is unlikely to back down: the German constitutional court could forbid an extension of existing bail-out funds; making help available without the spectre of bankruptcy could encourage reckless behaviour; and the German parliament will insist on getting private investors involved in future bail-outs.

European politicians and central bankers have criticised Germany for wanting to construct a eurozone insolvency procedure at a time of crisis. Investors are so spooked by possible losses that they have driven Irish and Portuguese borrowing costs to record levels. Yet Berlin is unlikely to back down.

 

The Germans fear that a simple extension of the current, ad-hoc bail-out funds would fall foul of Germany’s constitutional court. They predict that setting up a permanent rescue fund without the option of insolvency would encourage reckless government borrowing and thoughtless investment decisions. They argue that preparations for the new mechanism must start now if it is to be up and running by 2013, when the current bail-out funds expire.