Isaac: Chapter 9 offers Puerto Rico a path to solvency

THE WASHINGTON POST By William M. Isaac

A federal judge ruled on Feb. 6, 2015 that a Puerto Rico debt-restructuring law that aims to protect the government from bankruptcy and make public corporations self-sufficient is unconstitutional.  Above is the Capitol building in San Juan. (AP Photo/Ricardo Arduengo)

A federal judge ruled on Feb. 6, 2015 that a Puerto Rico debt-restructuring law that aims to protect the government from bankruptcy and make public corporations self-sufficient is unconstitutional. Above is the Capitol building in San Juan. (AP Photo/Ricardo Arduengo)

The Outrage Machine is a weekly opinion column by voices from the left and right on Washington.

This week, Puerto Rico faces another critical juncture in its debt crisis, as the House will devote simultaneous hearings to the island’s fiscal situation on Thursday. I will appear alongside a panel of other witnesses at the hearing before the House Financial Services’ Oversight and Investigations subcommittee, while Treasury Counselor Antonio Weiss will be the lone witness to testify before the House Natural Resources Committee.

Puerto Rico’s complex and increasingly severe debt crisis demands federal intervention and, ultimately, a significant debt restructuring. The urgency of this need is not lost on Washington, where there is rare bipartisan consensus in Congress and within the administration that lawmakers must act to offer the island debt relief and put in place policies to foster long-term economic growth.

As noted by Puerto Rico’s government and other observers, this is a task that presents significant challenges. The commonwealth has amassed a spiders’ web of debts from various issuers, each with their own legal guarantees and ranking, which amount to just under $70 billion in total obligations. For an island with an ever-shrinking population of only 3.5 million and an economy mired in a decade-long recession, this is an unsustainable debt load which inevitably must be subject to restructuring.

Yet, among frantic calls for a precedent-setting restructuring regime for United States territories, a simple fact seems often overlooked: Chapter 9 provides an existing legal framework which, if extended to Puerto Rico as it already is to states, can offer the island significant debt relief.

Prior to a mistaken 1984 amendment to the bankruptcy code, the commonwealth already had the power to permit its municipalities, utilities, and other public corporations to declare bankruptcy under Chapter 9. Correcting that error, and giving the island the same rights that states have enjoyed for nearly a century, is a politically viable means to restructure the debts of the island’s public corporations, municipalities, and instrumentalities – a large majority of the island’s total obligations.

Proponents of a broader restructuring regime, now frequently proposed in the form of a federally-appointed control board with restructuring powers uniquely applicable to U.S. territories, often claim that Chapter 9 modeled after what is available to states would be insufficient for Puerto Rico. This view is predicated on the flawed assumption that the island’s COFINA bonds would be exempt from a Chapter 9 restructuring.

This view is incorrect. The Puerto Rican government created the sales tax revenue-backed COFINA bonds in 2006, with the explicit purpose of using them to pay off existing debts. There is a strong argument to be made that the bonds were issued illegally in a blatant end-run of Puerto Rico’s 15 percent debt limit. The island’s own government has referred to them as “extra-constitutional,” and they certainly appear to violate the spirit, if not the letter, of that law. Regardless, COFINA is, and always has been, a public corporation. As such, Puerto Rico would be able to restructure this “extra-constitutional” debt as it would any other public corporation or instrumentality.

Of course, bankruptcy is not a panacea. Chapter 9 cannot, in and of itself, fix Puerto Rico’s fundamental problems nor can it encourage growth. Taken in tandem with a control board that has broad authority to reform the island’s fiscal practices, however, it can be an essential tool in giving the commonwealth breathing room while it makes changes. Chapter 9 can offer immediate relief from the commonwealth’s crushing debt burden, while a well-orchestrated control board can be the mechanism that sets Puerto Rico on the path to long-term growth and makes it an attractive place for outside investment.

Without growth-focused reforms, any solution for the island is merely a band-aide. Puerto Rico’s young and talented workers will continue to relocate to the mainland United States if there are no opportunities at home.

If implemented correctly, a reform-focused oversight mechanism, like the one that worked so brilliantly in Washington, D.C. in the 1990s, can balance the budget, downsize government, and greatly improve financial transparency free from domestic political interference.

Crucially, this board must be truly independent — its members must be appointed by the federal government and it must not have the ability to negotiate with creditors or abridge existing contracts. A non-independent board will sow resentment amongst the Puerto Rican people and rattle the investors that the commonwealth will need in order to regain access to the markets.

The commonwealth’s economy, though in dire straits, is not beyond repair. There is no doubt that the island must restructure a significant portion of its debts in addition to enacting growth-focused reforms. By supporting this multi-faceted solution, legislators can act decisively toward a resolution palatable for all parties, and, in doing so, reach heights rarely seen in terms of bipartisan leadership.

William M. Isaac, senior managing director of FTI Consulting, is former chairman of the Federal Deposit Insurance Corporation. The views expressed are his own.

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