March 20, 2017 12:53PM

Puerto Rico’s Half‐​Hearted Stab at Fiscal Reform Threatens the Island’s Long‐​Term Prospects

Puerto Rico Governor Ricardo Rossello and Federal Oversight Board Chairman Jose Carrion III will be in Washington this week to testify before Congress on the progress the Commonwealth has made since President Obama signed The Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) into law last summer. At the time, the press heralded the legislation as a bipartisan achievement and a legislative victory for House Speaker Paul Ryan, but that declaration of victory is beginning to appear a bit premature.

Eight months later, and six weeks before the bill’s stay on litigation expires, Governor Rossello and Chairman Carrion are expected to put forth a rosy picture of the situation on the status of PROMESA. However, it’s clear that the island’s government is headed in the wrong direction, precisely because the Commonwealth has failed to adhere to the tenets of the law.

The intent of PROMESA was to help Puerto Rico resume economic growth and achieve fiscal solvency after a decade of recession and budget deficits. Once that occurred the next goal was the eventual return to capital markets: since its default on general obligation bonds—which the island’s constitution explicitly guarantees—Puerto Rico has been shut off from capital markets.

PROMESA attempted to facilitate negotiations with the island’s many creditor groups. One way it did so was by imposing a stay on any litigation related to the island’s default on its secured bond payments. The stay expires on May 1st. It also created a court-supervised debt restructuring mechanism under Title III of the Act, which congressional leaders and the Oversight Board intended to be used only if negotiations with creditors prove fruitless.

Unfortunately, the current creditor negotiations have been fruitless, and by all appearances the Puerto Rican government intends to pursue Title III come May, which would jeopardize the Commonwealth’s ability to access the markets for years to come. There are several reasons the situation has reached this point:

  • There has yet to be any serious negotiations with creditors. Congress clearly intended for Puerto Rico to negotiate with creditors in good faith under Title VI, but this has not occurred—in fact, the Commonwealth asked Congress to extend the stay on litigation even though Puerto Rico has not even begun negotiating with its creditors.
  • The fiscal plan certified by the Oversight Board last week violates PROMESA. Section 201 of PROMESA avers that the fiscal plan should “respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws, or agreements of a covered territory or covered territorial instrumentality,” but the fiscal plan elevates several interests over the Commonwealth’s General Obligation bonds. Further, the plan alienates creditors by imposing only nominal reforms on the Commonwealth’s unsustainable pension obligations. It provides less than $800 million per year on debt service while allocating nearly 94% of revenue to other expenditures. The Commonwealth has also poked its bond creditors in the eye by defining almost its entire budget as “essential services,” making it difficult for any restructuring to accomplish much of anything except to reduce bond payments.
  • The Commonwealth has reneged on commitments to honor its obligations to bondholders. Earlier this year, Governor Rossello clawed back $150 million in funds set aside in a trust for General Obligation bondholders, a step required by Puerto Rico’s Constitution. In doing so he stated that the move was “the first action to comply with the general obligations since June of last year.” A week later, the governor’s representative to the Oversight Board, Elias Sanchez, said that “the trust is going to be solely for the purposes of GO payments.” Yet, just last week, the Commonwealth reneged on this commitment, saying that “We will not use one amount for certain credits and another for others. We will…use that number to renegotiate all the credits.”
  • Both the Puerto Rican Government and the Oversight Board are harming their own credibility by hewing to the tactics of Alejandro Garcia Padilla. Earlier this month, the Puerto Rican government retained the law firm Cleary Gottlieb Steen & Hamilton, agreeing to pay the firm $1.6 million through the end of June. This firm was the architect of Garcia Padilla Administration’s decision to default, in addition to advising former Argentine President Cristina Kirchner to default on its creditors. The Rossello Administration’s decision to retain Cleary’s services is yet another significant blow to its credibility and a sign that little will change when it comes to negotiating with creditors.

Bottom Line

There seems to be little hope of a near-term agreement between Puerto Rico and its various creditor groups. Declaring an impasse and accepting a de facto reorganization is clearly the preferred route for the government, as it would allow them to avoid making any hard spending decisions.

This unfortunate reality is a direct result of Puerto Rico’s lack of fealty to PROMESA, the tool Congress provided to Puerto Rico to fix itself. Puerto Rico’s actions—first under Governor Garcia Padilla and now under Governor Rossello—have damaged its credibility with markets and amount to short-term expediency over the long-run interests of the island’s residents. Congress should utilize its Oversight powers to urge Puerto Rico’s leaders to conform to PROMESA.