CATO INSTITUTE: published 4/5/17
PUERTO RICO CONTINUES TO IGNORE CONGRESS
April 6th, 2017
Puerto Rico came to Congress last year because it desperately needed some sort of help: after a decade of deficit financing, it is now $72 billion in the hole. It owes much of that money to traditional individual investors and savers across the United States, who have lent it money over the last decade, and even more to current and future pensioners.
The law that Speaker Ryan pushed through Congress, PROMESA, was meant to be that help. It provided the island’s government with breathing room to get its fiscal act together and authorized an Oversight Board to oversee its finances and–crucially–give it the political cover to make difficult decisions and negotiate with its many creditors.
Unfortunately, neither the government nor the Oversight Board have followed the law and, as a result, it looks destined to fall short of meeting its goals of restoring fiscal responsibility on the island and returning Puerto Rico to the capital markets.
To date, neither the Board nor the Puerto Rican government has had discussions with its creditors on either the development of the fiscal plan or any process for debt negotiations. Instead, their activities have culminated in the Oversight Board certifying a fiscal plan from the Commonwealth that falls short of–or outright ignores–requirements in PROMESA. The plan does relatively little to reform what’s broken in the Puerto Rico government, including wayward spending and a bloated pension system, and instead achieves short-run fiscal solvency via significant haircuts for the creditors that, in violation of the statute, do not comport with the lawful or constitutional priority of Puerto Rico’s obligations.
In response, a group of creditors that owns over $13 billion of the island’s debt recently sent a letter to the members of the island’s Oversight Board asking it to reject the government’s fiscal plan. The signees are a diverse group, including general obligation bondholders, COFINA bondholders, a bond insurer, and others who do not always share the same perspective. However, they all agree that the plan is so flawed it cannot be considered a serious starting place for debt negotiations. Key among their objections is that the fiscal plan clearly violates PROMESA by ignoring the law’s explicit call that it “respect the lawful priorities or lawful liens” that exist. The plan does this both by making debt subordinate to every single other government expense and by muddying the clear seniority of the various different creditor groups.
Some bondholders are clearly senior. For instance, the island’s constitution promises that the government will use “all available resources” to pay the holders of general obligation bonds before anyone else. That assurance allowed Puerto Rico to borrow that money at a low-interest rate relative to riskier revenue-backed bonds.
Others expect dedicated revenue pledges to be respected. For instance, COFINA bonds, created to offer deficit borrowing capacity beyond the constitutional limit on general obligation debt, are backed by revenue generated by the island’s sales tax. Whether that diversion of resources was legal remains to be seen, but Puerto Rico managed to increase its borrowing capacity by promising these bondholders first dibs on this revenue stream.
Yet, in spite of the clear seniority of these creditors, the governor recently proposed what amounts to a magnanimous side deal with creditors of Puerto Rico’s utility–PREPA–that excludes these and all other creditors, a maneuver that makes little sense and smacks of political favoritism. It will almost certainly prolong negotiations with other creditors and potentially derail the credit markets’ faith and interest in helping Puerto Rico build a future.
The issue of debt priority is not the only infirmity of the plan highlighted by creditors. For starters, top line expenses grow by billions rather than shrink. There is an annual cushion of $600 million for anticipated deficits beyond the plan for the various agencies outside the general fund. It budgets $500 million per annum for infrastructure spending without considering that much of this could be privately financed–although investors may be naturally wary of lending money to any entity on the island, no matter what is promised. And all this is against a forecast of revenue declines unsupported by historical experience or analysis.
Meanwhile, the island’s pension, which is $48 billion in the hole, would not see any significant reductions in benefits or any other changes. In fact, there is little fiscal reform anywhere to be found in the budget: it calls for payroll expenses to increase by $1.5 billion in the next decade, with operational expenses rising by $400 million as well. In no way does this budget present a step towards fiscal solvency.
Moreover, the plan’s call for bondholders to be compensated only after the island meets its other obligations makes a mockery of PROMESA. The budget calls for just $400 million to be set aside for bondholders in 2018, when $2.3 billion of interest payments will be due.
The island’s new governor, Ricardo Rosselló, has made achieving statehood a primary goal of his administration. However, the political reality is that there’s already little appetite for such a thing amongst the Republican Congress, and his manifest refusal to deal squarely with its fiscal morass only hurts the cause. Even Governor Rosselló admits the island’s government has a sizeable credibility gap. Its continued refusal to share pertinent financial information with Congress more than six months after the passage of PROMESA is only the most recent manifestation of the inherent problem here.
For Puerto Rico to ever have a chance to become a state–and to avoid it becoming a new federal entitlement–it has to fix its fiscal problems and restore its credibility. Its proposed budget does little to reform the economy and promises to keep the island shut out of capital markets for years to come.
Even worse, allowing the Commonwealth and Oversight Board to flout the principles of PROMESA will increase the potential liability at the federal level. Without access to the markets and no respect for private contracts, revenues will decline and the prospects for growth will vanish, and the island’s 3.5 million citizens will continue fleeing to the mainland.
There are already several state governments with woebegone budget problems that may be looking down the road towards some sort of federal bailout. No one has any appetite to add another to the list–not when the Republicans already spent a modicum of political capital to pass PROMESA in the first place. The side deal with PREPA only exacerbated an already bad situation.
For Puerto Rico to ever have a chance to become a state it has to first fix its fiscal problems and resume economic growth. The proposed budget does little to reform the economy and promises to keep the island shut out of capital markets for years to come.
GMS Commentary: The Oversight Board and the Puerto Rico government's approach to debt restructuring and the Board approved Puerto Rico Fiscal Plan appear to be illegal as neither respect creditor rights or remotely comply with the law the U.S. Congress passed "PROMESA". The situation is fluid, debtor and creditor positions may change often until May 1st when the legal stay invoked under "PROMESA" expires. At that point, if current differences remain unresolved, creditors will likely ask the court to rule that the Puerto Rico Fiscal Plan does not follow "PROMESA". For current informa-tion or should you have questions, contact your GMS account executive.
Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.