Bankruptcy is wrong for Puerto Rico

The HillBy Nader Tavakoli – Treasury Secretary Jack Lew recently visited Puerto Rico in an effort to show the administration’s support for the beleaguered territory. Lew’s comments on his trip to San Juan and his January 15 letter to House Speaker Paul Ryan (R-Wis.) make it clear that when it comes to Puerto Rico, the administration largely equates “support” with “bankruptcy.”

The administration’s well-intentioned desire to help the people of Puerto Rico is laudable, but it is a mistake to give Puerto Rico the power to rewrite its laws and contracts through a retroactive application of new bankruptcy laws. The administration’s position is neither good policy for Puerto Rico nor the United States.

Ambac is one of the country’s largest guarantors of municipal and state debt. In Puerto Rico, we insure well over $2 billion of the Commonwealth’s various debt obligations, and our commitments to the island extend until the year 2054. Our financial support of the Commonwealth helped build its roads, bridges, schools, hospitals, police and firehouses. We have a very long-term commitment to Puerto Rico, and nothing is more important to us than Puerto Rico’s economic viability and prosperity.

That is why we are convinced bankruptcy would be ineffectual at best and counterproductive. Ambac estimates less than one third of Puerto Rico’s debt could be subject to a bankruptcy as only a few of its 18 issuers would qualify for bankruptcy. A bankruptcy would add layers of complex litigation, cost hundreds of millions of dollars, and take years to complete.

A bankruptcy of Puerto Rico would be many times larger and more complex than the bankruptcy of Detroit, which cost about $180 million. As with Detroit, a bankruptcy would shut Puerto Rico out of the capital markets, increase borrowing rates and severely reduce financial flexibility for the foreseeable future. It would drive away private investment as investors question the territory’s respect for rule of law. Most importantly, a bankruptcy would undoubtedly be used to avoid or delay fiscal and structural reforms that are desperately needed to strengthen Puerto Rico’s fiscal position and grow its economy. The cost of the bankruptcy itself and the resulting increased borrowing costs and economic dislocation for the Commonwealth would substantially exceed any potential debt reduction.

The American capital system is unique and the envy of the world, based on the ability of contracting parties to rely on the rule of law, and against government taking, when assessing risk and reward in entering into financial relationships. By proposing to retroactively rewrite contracts, laws and even the Constitution of Puerto Rico as applied to investors’ relationships with Puerto Rico, the Treasury secretary shows inexplicable disregard for a cornerstone of our economic foundation.

A bankruptcy of Puerto Rico is not necessary or warranted. By all accounts Puerto Rico has greatly mismanaged its affairs, undertaken decades of profligate overspending, failed to submit required financial statements, and even admitted to misleading investors in order to access the financial markets. While Puerto Rico has a largely self-inflicted liquidity problem, it can sustain its debt and tax burdens. Total debt is 98 percent of GDP compared to 118 percent for the US. Total taxes paid are only 11 percent of GDP, roughly half that of the US. Despite claims of exhaustive austerity measures, Puerto Rico’s government expenditures have increased 47 percent from 2003 to 2013 and remain near an all-time high. Puerto Rico’s total government spending as a percent of GDP is higher than that of any state of the US. By proposing to bail out Puerto Rico through bankruptcy, the Administration is asking Congress to condone financial misconduct.

A responsible solution requires meaningful fiscal and structural reforms that enable Puerto Rico to honor its financial obligations, restore fiscal discipline and grow its economy. Even without any harsh measures, economists estimate that the Commonwealth can reduce annual expenditures by at least $1.5 to $2 billion and increase revenues by at least $500 million to $1 billion. There is plenty of fat to be trimmed. For starters, the Commonwealth could rationalize its 130 agencies, 15 departments and 78 municipalities, centralize procurement for goods and services, and consolidate and centralize applications for federal funds. It could significantly increase revenues by updating property tax valuations and improving tax compliance from an estimated 56 percent to a level closer to the U.S. average of 83 percent. An improvement in tax collection rates to 70 percent could increase annual revenues by more than $500 million. A meaningful privatization program could remove a quarter of the Commonwealth’s debt from its balance sheet and attract significant private investment that would generate new jobs.

These solutions are responsible and should be achievable, however, the current fractured political environment in Puerto Rico appears to prevent their urgent consideration and implementation. Lew recognizes the necessity for an external body to help Puerto Rico get its financial house in order, as evidenced by his urging Ryan to appoint a control board.

A federally appointed control board would be able to take the obvious steps needed to set Puerto Rico on the path to fiscal recovery and sustainable economic growth. We need look no further than Washington, DC. Twenty years ago, on the brink of disaster, the District of Columbia was put under the management of a Control Board. It is worth noting, this decision was made through the collaboration of a Republican Congress and a Democratic administration, and bankruptcy was explicitly considered but rejected. The result has been a stunning success, in stark contrast to the fate of Detroit.

In addition to creating and implementing a blueprint for fiscal recovery, a Control Board will end the gamesmanship that is aimed at nothing more than giving the governor a free pass to avoid paying the Commonwealth’s debt. We remain eager to engage with the government of Puerto Rico in good faith discussions to craft responsible solutions that enable it to honor its financial obligations, regain access to the capital markets and grow its economy.

Tavakoli is president and CEO of Ambac Financial Group.

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