Puerto Rico’s Hamiltonian moment

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By Lawrence J. Spiwak -Puerto Rico is a beautiful island with a vibrant and proud culture. It is also a financial basket case. After years of profligate spending, Puerto Rico is up to its eyeballs in debt to the tune of $72 billion, and the time has come to pay the piper. The problem is that the impoverished, economically depressed island of 3.5 million people is flat broke and can’t repay its debts. As Puerto Rico’s Gov. Alejandro García Padilla laments, “This is not politics, this is math.”

So what to do?

In this particular case, some of the debt in question is secured by a provision in Puerto Rico’s Constitution, which guarantees that bondholders be paid back before other creditors. As such, the prudent option is for the government of Puerto Rico, perhaps with a little help from more responsible parties, to negotiate a settlement with these priority bondholders as well as to implement some much-needed reforms. As we are in the middle of a tumultuous election cycle, however, prudency is in short supply in Washington.

Instead, there are growing calls for Congress to pass the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). This bill would, among other things, sets up an oversight board for Puerto Rico with the power to bring suit in federal district court under multiple provisions of the U.S. bankruptcy code. While this solution sounds innocuous enough, the practical effect of PROMESA would be to remove the preferred creditor status currently guaranteed by the Constitution of Puerto Rico and allow a court to cram-down bondholders to accept pennies on the dollar.
For some in both political parties, the PROMESA approach to solve the Puerto Rico debt crisis is appealing. Liberals love the idea because it fits comfortably into their narrative to demonize everything related to Wall Street and so-called “vulture capitalists” (see, for example, the recent John Oliver tirade on this very topic). Conservatives love the idea because PROMESA is not technically a “bailout” — U.S. taxpayers at large are not on the hook because the bondholders take the haircut. For those who care both about the rule of law and the long-term health of the financial system rather than mere short-run political impacts, however, this “ends justifies the means” mentality should raise some serious red flags.

Under the plain terms of Article VI, Section 8 of Puerto Rico’s Constitution, “[i]n case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.” (Emphasis supplied.) In other words, lenders underwrote Puerto Rico’s general obligation debt because the government put its full faith and credit on the line — the ultimate collateral — to make sure bondholders got paid first before other unsecured creditors and other government expenses. Equally as important, it was well understood (and fully disclosed) at the time of issuance that these bonds would not be subject to U.S. bankruptcy law, giving the underwriters further confidence that these bonds would be repaid first if Puerto Rico’s ability to service its debt went south.

Yet, despite the terms of this debt being well understood by all, Puerto Rico’s profligate spending continued. But with the territory now flat broke, folks want the United States Congress to step in and change the rules for Puerto Rico. The problem is that should Congress take the bait, such action will send a huge signal to capital markets that nothing is certain when it comes to municipal finance. This uncertainty (which investors loathe) will then infect every other municipal finance project, requiring higher interest rates to reflect increased risk. And, if the market perceives this risk is too high, then we may even see a reduction of credit for municipal bonds overall, raising, perhaps significantly, debt costs to U.S. cities. Undue influence in Puerto Rico is a slippery slope that will not end well.

There are also broader due process concerns at play. Having the U.S. federal government move the goalposts after the game begins reeks of political cronyism and will inevitably lead to years of protracted litigation. And if Congress can come in and move the goal posts after things go south in the case of Puerto Rico to assuage select political constituencies, then what’s to stop Congress from doing it in another? Absolutely nothing.

Without a doubt, the Puerto Rican debt crisis is a travesty and people are hurting. Aggressive steps must be taken to right the ship. That being said, it’s time for Puerto Rico’s government to sleep in the bed it has made. As columnist George Will recently noted, “[t]he more Puerto Rico is allowed to evade existing legal processes and the need to negotiate with creditors, the more leeway it will have to resist reforms.”

Allowing Puerto Rico to take advantage of PROMESA’s bankruptcy provisions would make a mockery of the Hamiltonian notion that a government must stand behind its obligations with its full faith and credit. Instead, all we would do in passing PROMESA is to convert “full faith” to bad faith, and that’s no way to run a republic.

Spiwak is the president of the Phoenix Center for Advanced Legal & Economic Public Policy Studies, a nonprofit 501(c)(3) research organization that studies broad public-policy issues related to governance, social and economic conditions, with a particular emphasis on the law and economics of the digital age.

 

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