Puerto Rico's Bankruptcy Is the Next Step in its Slow Dance of Default

COMMENTARY Americas

Puerto Rico's Bankruptcy Is the Next Step in its Slow Dance of Default

Jul 10th, 2017 3 min read
COMMENTARY BY
Salim Furth, Ph.D.

Research Fellow, Macroeconomics

Salim is a Research Fellow in Macroeconomics at The Heritage Foundation.
Puerto Rico’s slow dance of default may continue for years as creditors battle the Oversight Board in local and federal courts. iStock

Last Wednesday, the Financial Oversight and Management Board for Puerto Rico, created by Congress last year, formally requested the appointment of a federal judge to oversee bankruptcy proceedings for the indebted U.S. territory. The proceedings are authorized under Title III of the Puerto Rico Oversight, Management and Economic Stability Act of 2016 (PROMESA).

The well-choreographed move fits into the larger sequence of events intended in PROMESA. A 10-month stay on litigation against the government of Puerto Rico expired last Monday, precipitating a rush to the courthouse by creditors. But with initiation of the Title III bankruptcy proceedings, the stay goes back into place, putting the lawsuits on ice for another 120 days.

On Wednesday morning, one of the law’s architects, Antonio Weiss, called for Title III’s immediate use in remarks at the American Enterprise Institute. “The legislative intent,” Weiss argued, “was for there never to be a break in that stay.”

His encouragement was unnecessary. Puerto Rico Gov. Ricardo Rosselló had sent a request to initiate Title III a few minutes before Weiss took the stage. By the end of the day, the Oversight Board had approved and filed the governor’s request.

The 10-month stay improved Puerto Rico’s position at the bargaining table. It froze debt payments, so Puerto Rico could default on $2 billion since PROMESA was signed. The stay also allowed Puerto Rican voters time to choose a new governor to guide them through the process and to preemptively initiate reforms. Finally, the governor and the board agreed on a fiscal plan under cover of the stay.

The governor’s first draft of a fiscal plan called for repaying $1.2 billion of the approximately $3 billion per year owed to creditors. The Oversight Board rejected that plan as too optimistic, and they approved one that budgets $800 million a year in repayments. The plan also calls for a 10 percent cut to pension outlays by 2020.

PROMESA stipulates that the governor’s fiscal plan will guide bankruptcy proceedings. If Title III survives court challenges brought by bond insurers, then the size of the creditors’ pie is fixed, at least for the next several years, and the judge’s job is to dole out the scraps.

One section of PROMESA remains little used. Title VI provided for mostly-voluntary agreements between creditors and the government. But, as Rachel Greszler and I wrote in 2016, “collective action clauses are little comfort to a creditor facing an oversight board with a ‘fiscal plan’ of its own and the power to enforce it with the normal legal process sidelined.”

Among the creditors, the big winners are those who lent to the Puerto Rico Electric Power Authority (PREPA), the island’s public electric utility. PREPA was the canary in the coal mine, and its creditors organized themselves early and had the structure of a voluntary debt restructuring reached before PROMESA was drafted. Negotiations continued through April, resulting in an agreement (pending Oversight Board approval) that would give creditors 85 cents on the dollar.

The contrast between the PREPA deal — which was largely worked out under existing law prior to PROMESA — and the likely fate of creditors of other public utilities is instructive. Existing law provided tough but fair discipline for publicly owned corporations that did not pay their debts. They could go into receivership or even be privatized. In the case of the electric utility, reform means cutting off freeloading “customers,” stopping paychecks to absentee “workers,” and developing public-private partnerships for power generation.

In the Title III process, however, the other indebted utilities will get to default on more of their debt, and reform will be filtered through the political process. That serves the people of Puerto Rico poorly. Politics has meant patronage for the few and poor service for the many. While PROMESA averted lawsuits, it also averted some badly-needed reforms. As Gov. Rosselló himself said at The Heritage Foundation last week, “If you can find it in the Yellow Pages, you need to ask yourself if the government should be doing it.”

Under PROMESA, the governor will be fighting an uphill battle against entrenched political interests wherever he tries to shrink the bureaucracy or privatize a service that belongs in the Yellow Pages. Without PROMESA, creditors would have forced the issue.

Puerto Rico’s slow dance of default may continue for years as creditors battle the Oversight Board in local and federal courts. Bond markets will watch that fight with interest. Others, however, are already turning to the key player: Gov. Rosselló.

He can give Puerto Rico a chance of success by building on early reforms to labor markets and construction permitting and by delivering on his campaign promise to shrink the government’s 131 agencies down to a svelte 40. Introducing him last week, I said he had “the hardest job in politics.” It is not about to get easier.

This piece originally appeared in The Hill on 5/7/17