House Approves Puerto Rico Bailout; Short-Changes Bondholders
Come July 1 is D-Day. On that date, Puerto Rico is set to default on nearly $2 billion in general obligation bonds. In response, Congress is trying to wrap up legislation allowing the island to declare Chapter 9 bankruptcy on $18 billion of over $70 billion in outstanding debt. On June 9, the House passed the Puerto Rico Oversight, Management and Economic Stability Act, by 297-127. Senate Majority Leader Mitch McConnell, R-Ky., also vows action. A seven-member board will exercise oversight. Supporters insist the bill is a restructuring, not a bailout. Don’t believe them. Not only is it a bailout, it is of a type unavailable to the 50 states. Bondholders will pay. To its credit, the Supreme Court ruled 5-2 last Monday, June 13, that a Puerto Rican law inspiring the House bill violated the U.S. bankruptcy code.
National Legal and Policy Center twice before has explained the origins, dimensions and consequences of the Puerto Rican economic implosion, in December 2013 and again in August 2015. That an implosion is occurring is indisputable. Puerto Rico has an estimated $72 billion (some observers say $73 billion) in outstanding bonds rated near or at “junk” levels. That represents about $20,000 for every man, woman and child on the island. With its population increasingly packing up and moving to these shores – Florida is by far the most common destination – Puerto Rico faces an economic collapse potentially rivaling the one happening in Venezuela. Puerto Rico’s unemployment rate is hovering around 15 percent. A third or more of its residents are on food stamps. The government is rationing water. The union-driven public employee pension system is underfunded by $46 billion. Violent crime, especially murder, is at shockingly high levels. The Zika virus is creating a public health crisis. Puerto Rican Governor Alejandro Garcia Padilla, pleading for aid, testified before the Senate Judiciary Committee last December 2 that his government has “no cash left.” All told, it’s not a pretty picture.
Complicating the economic conundrums is Puerto Rico’s political system, an awkward hybrid of sovereignty, colonialism and statehood. Puerto Ricans have a distinct ethnic and linguistic identity, but they do not have a country to call their own. They increasingly favor statehood, but their support is far from overwhelming. An independence movement has existed for decades, but it represents a small minority. The relationship between the territorial government and our own remains cordial, but strains are showing. Having to cover debts will do that to a country. And U.S. investors may have to cover them. Back in 2013, when it had become clear that a bad situation had become intolerable, three out of four of the more than 400 municipal bond mutual funds in this country had at least some Puerto Rican bonds in their portfolios; fully 55 such funds had at least 10 percent of their assets in Puerto Rico. If these creditors are denied their income stream by government fiat, it is virtually certain they will file lawsuits. Whether there is anything to collect beyond pennies on the dollar is an open question.
Lawmakers on Capitol Hill have come to see debt restructuring as the only feasible way to insulate the island from collapse. Having tried a couple of times previously, they have come up with what they see as an acceptable compromise proposal: the Puerto Rico Oversight, Management and Economic Stability Act. The bill, which originated in the House Natural Resources Committee, has a clever acronym, PROMESA, which by no coincidence is Spanish for “promise.” Rep. Sean Duffy, R-Wisc., a key sponsor, promises that the legislation will balance interests of debtors and creditors, while averting catastrophe. Without it, he remarked, “the Puerto Rican government is likely to collapse, participants in public pension plans will be terribly damaged, and almost all bondholders could lose their investments.” House Minority Whip Steny Hoyer, D-Md., likewise stated: “In a world of alternatives, this is an alternative we need to take.” House Speaker Paul Ryan, R-Wisc., House Minority Leader Nancy Pelosi, D-Calif., and Treasury Secretary Jack Lew each have expressed support as well. Speaker Ryan (in photo) put it this way on the eve of the House vote: “This bill prevents a bailout. That’s the entire point. If we do not pass this bill, then there is much more likely going to be a bailout because there is no other choice.” He got his wish on June 9.
The Senate is likely to take up a vote soon. Majority Leader Mitch McConnell, R-Ky., has indicated he wants a vote. He’s likely to run into resistance. Late last year, during a hearing of the Senate Judiciary Committee, Sen. Charles Grassley, R-Iowa, reminded his colleagues: “Let’s not forget that Puerto Rico issued its bonds with the knowledge that Chapter 9 bankruptcy wasn’t an option in the event of default. Is it fair to retroactively change the rules at the expense of these investors, if other options exist for addressing Puerto Rico’s debt problems?” Puerto Rican aid advocates, at least, are getting help from former Senator Judd Gregg, R-N.H. Now a consultant for mainland bondholders, Gregg, in a June 16 editorial for CNBC, praised the PROMESA bill as sound fiscal discipline:
The reality is Puerto Rico finds itself on the verge of economic cardiac arrest following decades of contraction, population flight and excessive spending. Although some interested parties have cast this crisis as a Washington-to-Wall Street issue, it is the Puerto Rican people who have been enduring the plight of poor government accountability and a regressing social infrastructure.
As a policy advisor to institutional and retail investors holding senior bonds backed by Puerto Rico’s sales tax revenues, I counsel a group that has “skin in the game” on the island and seeks to stem migration out of Puerto Rico to the mainland. That is why I have advised supporting legislation that pairs a respect for creditors’ rights with a process for achieving economic stability, government reform and creating an environment for growth.
On the surface, this view appears reasonable. Puerto Rico is experiencing a debt crisis. More than once the island has defaulted on scheduled payments, most recently this May to the tune of $370 million. Bankruptcy would create an opportunity to reorganize. A number of U.S. cities, most notably Detroit and Stockton, have gone the same route and managed to get back on track. Moreover, if the proposal stems the tide of migration from Puerto Rico, as its backers claim, our nation would be spared the expense and time of having to assimilate a lot of newcomers.
But before jumping in, let’s understand the downside of all this. Supporters of PROMESA downplay just how Puerto Rico got into this predicament. They gloss over the fact that by making Chapter 9 bankruptcy available to Puerto Rico, we effectively would be assigning to that island a higher legal status than that assigned to all 50 states. They have little or no problem with a grant of Chapter 9 authority to Puerto Rico heightening pressure to elevate the island to statehood. And they are advocating something that in all likelihood will not survive a court challenge. Let us flesh out these and other objections.
First, PROMESA likely is illegal. That’s not mere conjecture. Last Monday, June 13, the U.S. Supreme Court ruled by 5 to 2 that the Commonwealth of Puerto Rico, on its own, cannot file for Chapter 9 bankruptcy. Back in 1984, Congress passed a law explicitly barring this option, which is open to mainland municipalities and special purpose government agencies. Yet in 2014, Puerto Rican authorities, as a desperation move, passed something called the Recovery Act that would restructure more than $20 billion worth of debt. Creditors sued to invalidate the law, arguing that it ran counter to the U.S. Bankruptcy Code. A Boston federal circuit court in February 2015 ruled in favor of the creditors. Puerto Rican officials promptly appealed to the Supreme Court, winning legal standing in December. But last week on June 13 the High Court ruled that federal law must prevail. Writing for the majority, Justice Clarence Thomas stated: “The plain text of the Bankruptcy Code begins and ends our analysis.” Had Congress wanted to allow Puerto Rico to adopt bankruptcy provisions like this, he argued, it “would have said so.” Granted, PROMESA is not the Recovery Act. Yet the motive behind each law is similar. If the Supreme Court can invalidate the Recovery Act, it is capable of doing likewise with PROMESA, especially given that the bill runs counter to the Puerto Rican constitution (Article VI, Section 8), which states “interest on the public debt and amortization thereof shall be paid first.” Constitutionally-issued debt, as Rep. Tom McClintock, R-Calif., noted in his floor speech, is fundamentally different from standard government debt.
Second, the debt crisis has the words “Made in Puerto Rico” written all over it. Territorial leaders and allied interest groups may carp all they want, but it was decades of domestic incompetence and corruption that brought the island to its current morass, and not political, economic or cultural imperialism up north.
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