Originally published by The Washington Times on April 18, 2017.
Congress wisely declined to bail out Puerto Rico when its leaders turned to Washington with hat in hand for help with its $70 billion debt. Instead, they created an oversight board to compel the island commonwealth to solve its self-inflicted fiscal mess. Unfortunately, both the oversight board and the territory’s government have failed to adhere to congressional requirements and are not taking the bold steps necessary to spur economic growth and fix Puerto Rico’s finances.
The Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) was passed by Congress last year and aimed to restore fiscal responsibility to the commonwealth. In addition to creating the oversight board and tasking it with overseeing the island’s finances, the act provided a stay on litigation in order to give the government time to negotiate with bondholders. Crucially, it also mandated that any fiscal plan would “respect the lawful priorities or lawful liens, as may be applicable in the constitution, other laws, or agreements of a covered territory.”
Some debt restructuring is a necessary component of any realistic solution for Puerto Rico. How exactly that is accomplished makes a big difference, however. The island will eventually need access to bond markets again, which means excessive haircuts aren’t going to work. Nor can it play favorites and advantage certain debt-holders over others or ignore the legally established priorities. There won’t be many willing to lend to Puerto Rico in the future if rules are ignored.
Unfortunately, the government and the oversight board have not attempted to work with debt-holders in good faith. Instead, they’ve put forward a plan that ignores PROMESA’s requirement of respect for lawful priorities by advantaging certain interests over the general obligation debt that is guaranteed by the island’s constitution. The plan also only provides $800 million in debt service per year while keeping nearly 94 percent of revenue for other expenditures. There is virtually no fiscal reform — in fact, the budget plan calls for significant increases in payroll and operational expenses over the next decade — and no significant changes to the island’s pension system with its whopping $48 billion debt.
The plan does not represent the serious reforms that PROMESA was designed to bring about.
To make matters worse, the plan proposes a side deal to creditors of the Puerto Rico Electric Power Authority (PREPA), that would limit its bondholders to a 15 percent haircut while other debt-holders are likely to face haircuts of 77 percent under the current plan. A recent agreement reached between PREPA and its creditors imposing the 15 percent haircut and a new charge on consumers should likewise be rejected by the oversight board.
It would send a bad signal to credit markets if the commonwealth is able to renege on its constitutional pledge to prioritize general obligation bondholders. It shouldn’t be too much to ask that negotiations proceed fairly with all of the different creditor groups. They also must look at real spending reform and not try to balance on the backs of creditors alone.
Unfortunately, the government has sought to game the system by defining the vast majority of its budget as “essential services.” When it likely later invokes Title III of PROMESA, a court-supervised debt restructuring mechanism intended to be used only after negotiations with creditors fail to reach a satisfactory agreement, this designation will allow most spending to remain intact and unfairly put the bulk of the cuts on creditors. It would be bankruptcy by another name that Congress specifically sought to avoid.
And despite not attempting to negotiate with creditors, Puerto Rico has asked for the stay on litigation to be extended past its May 1 expiration. It’s not that costly litigation is desirable, of course, but an extension would only encourage the continued disregard of PROMESA’s requirements. Instead, Puerto Rico should be pressured to bring all bondholders to the table and negotiate honestly, and to make hard choices about spending cuts.
Ultimately, what the commonwealth needs is economic growth. With a stronger economy there will be more for everyone, and with common-sense fiscal restraint, the island will have a chance to grow out of its debt. There are actions Congress can and should take to make that growth more likely, but in the meantime, it must insist that the commonwealth’s government and the oversight board follow the requirements of PROMESA and respect the rule of law. Puerto Rico can’t afford to savage creditors to the point that investors lose confidence and jeopardize its ability to borrow, hopefully at more reasonable levels, in the future.