Commentary: Just Wipe Out Public Debt! — Not a Solution for Puerto Rico or Anyone Else
– by James Spiotto
With the end of the flurry of Congressional activity over impeachment, followed by a general yearning for the end to partisan conflicts, we now look to this year and what issues can be addressed before the national election. There remain lingering issues that are now left for 2020: infrastructure funding, immigration reform, public safety initiatives, health care enhancement, drug cost reduction and numerous other matters that should and do unite us. Some, like impeachment, divide us. However, there is one bill under discussion that should unite all of us in a determination that the proposed legislation should be buried once and for all. The U.S. House Natural Resources Committee held hearings on October 22nd and October 30th to consider a discussion draft bill that would allow the Puerto Rico Legislature and Governor to enact a resolution wiping out virtually all of Puerto Rico’s Public Debt – whatever remains unresolved of over $72 billion. This elimination of debt would be without justification or any pretense of due process. Even debt secured by a pledge of future tax revenues would be deemed unsecured and eliminated unless the creditor claiming a security interest could prove to a court in Puerto Rico that it is secured. However, pledges of future tax revenues to be collected after the date of the resolution would not be included in the calculation of secured status, thereby turning the principles of government finance on their head and frustrating the constitutional prohibition of taking property (security) without just compensation – a bankruptcy NO NO.
Contrary to the premise of this bill, Public Debt is not the cause of Puerto Rico’s or any government’s financial distress. Public Debt is a symptom of a systemic problem – economic meltdown. For Puerto Rico, the real causes are all too clear: the Congressional repeal without replacement in 2006 of Section 936 of the IRS Code that, through tax breaks, had encouraged economic development, the Jones Act adding 10-15% to the price of goods carried by US vessels compared to the cheaper prohibited use of foreign vessels, inequitable federal policy as to funding and treatment of Medicaid and taxation for Puerto Rico compared to the States. Puerto Rico claims this costs Puerto Rico billions annually, and all of this is fertile grounds for blame, but not Public Debt.
The blanket elimination of Public Debt of a government is unprecedented in the history of state and local government financing, which has an overall average annual default rate of approximately 1/50 of 1% going back as far as 1839. Unlike Puerto Rico, since the late 1800’s, no state has defaulted and not refinanced and paid in full its general obligation debt. Chapter 9, Municipal Debt Adjustment, is just that, an adjustment to that which is affordable, not a complete wipe out of unsecured debt. Recent examples of sovereign debt defaults are Greece, Brazil, Argentina, Ukraine and Ecuador. Between 1978-2010, there were 180 sovereign debt restructurings with a mean haircut of debt of only 37%. Even Detroit’s Chapter 9 had an average debt haircut of 38%.
Further, this drastic and unprecedented elimination of Public Debt will cast a fatal financial stigma on Puerto Rico with dire consequences, including dramatically increasing its future cost of borrowing – the opposite of what is desired. At a recent Congressional hearing, Natalie Jaresko, executive director of the Congressional created Financial Oversight and Management Board for Puerto Rico ( “FOMB”), said eliminating the debt “may make it harder and more expensive “ to access capital. The resulting increased cost of borrowing would make less funds available for government services and taxpayer relief. For an island struggling to regain credibility in the capital markets, wiping out the debt is the wrong solution. Greece’s restructuring was about a 50% haircut for banks and bondholders in a negotiated restructuring, but on March 2, 2012, Greece had a ten-year bond annual yield of 37.1%, and in July 2015, after the third attempted bailout, Greece had an annual yield on its ten-year bond of 10.5%. Brazil with eleven debt restructurings since 1826, the last time in 1990, had a ten-year bond annual yield between 2006 and 2015 of approximately 12.3%. At the same time, U.S.A., Canada, Germany and France had ten-year bond yields ranging from .74% to 2.27%. Just 2% more in annual interest cost can add 15-25% of the original principal amount in present value additional interest cost or 15-25% less of the principal borrowed being available for government services or taxpayer relief.
Unprecedented debt cancellation would be another example of unsuccessful manipulation of economic forces. Investors will not put their money into something which almost guarantees a loss. Without legitimate investment, real financial recovery for Puerto Rico will never come.
What should Congress do? Certainly reject the bill to wipe out Public Debt. Congress must take the time to pass a legitimate, forward-looking plan supported by qualified financial experts to stimulate reinvestment in Puerto Rico, which can be used to encourage economic development, increase tax revenues and facilitate paying down the debt while reestablishing the island’s access to capital markets. Congress should enact a “Marshall “-like plan for Puerto Rico by investment and recovery, with over $91 billion of authorized Federal Disaster Aid over the next 20 years which now should be front-end loaded. The coordination and implementation of this aid should be used to effectively and efficiently reinvest in Puerto Rico with the next generation of infrastructure and services to stimulate and support economic development, recovery and financial stability.
Congress can enact legislation to replace Section 936 of the IRS Code with tax and other incentives for attracting new businesses and encouraging existing businesses to expand in Puerto Rico, creating the new good jobs with accompanying new corporate and individual taxpayers that will significantly increase tax revenues, which creates the high tide that raises all boats. This high tide will move the 40% labor participation rate of Puerto Rico closer to the 62% U.S. average and lower the 45% poverty rate closer to the 12-15% U.S. average. Further, restructuring and payments of Public Debt will be facilitated by a reinvestment in and recovery of Puerto Rico with the infrastructure necessary to make Puerto Rico a center of finance and commerce for the Caribbean. The best means of dealing with Public Debt is to rebuild the economy, services and infrastructure in order to have the credibility to be able, not only to repay restructured debt, but also to address the needs for governmental services to the level desired and acceptable. Congress can further assist this by supporting a restructuring or tender offer for Public Debt at a reasonable level backed by federal assurance of payment like the “Brady Bonds “ of the 1980’s for Mexico and Latin America that provided lower interest rates and greater market acceptance, the makings of the high-tide of economic stimulus desired by all.
In the Debt Restructuring Court Proceeding for Puerto Rico, the Court last July stayed litigation to give a mediated resolution a chance. After over four months of that additional mediation effort, the recent Mediator Interim Report set forth a time schedule for determination of numerous weighty lingering legal issues. However, what the PROMESA experience has shown is that one court determination does not bring parties together but rather leads to one appeal after another and many times creating greater division than resolution.
The Oversight Board has recently, on February 9, 2020, proposed another revised Plan of Debt Adjustment, but various groups of creditors, small and large, are presently opposed to their treatment thereunder. While the revised plan proposes recoveries for G.O. and PBA Bond ranging from 54% to 76% of their claims as of March 1, 2020, it is far from the threatened “wipe out “ but also far from the constitutional priority for G.O. Bonds promised at issuance. The proposed overall recovery for all creditors of 37.4% is in stark contrast and turns on its head the average haircut to creditors of 37% in recent sovereign debt restructurings. Further, Employee Retirement Bonds, Clawback Bonds and others totaling $16 billion are to receive a 3% or less recovery that is counter-productive to developing any general acceptance even reluctantly obtained.
The hallmark of a large municipal Chapter 9 Plan is that, at confirmation, virtually all creditors, especially the large ones, have consented, albeit sometime reluctantly. That general consensus now is missing in the Puerto Rico process. Given the troublesome legal issues to be resolved by U.S. Supreme Court appeals or by District Court litigation, the Oversight Board should be concerned as to its ability to confirm a Plan that is not consensual with the vast majority of creditors, including major creditors, not in agreement.
As this new year unfolds, we should hope for the Oversight Board, Puerto Rico and its creditors to negotiate a resolution that does not sacrifice the essential principles of municipal finance and together to join in the effort to have Congress pass legislation that remedies past inequities. This should include addressing the Jones Act and Tax policies and reinstating an economic stimulus like Section 936 or similar tax encouragement to attract new business and expansion of economic development for Puerto Rico. A Congressional-sponsored “Marshall Plan “ to reinvest and rebuild Puerto Rico’s infrastructure is the best response and defense to the ravages of the ill winds of hurricanes like Maria and the destructive eruptions of recent earthquakes. Congress could authorize a synthetic Brady Bond assurance, for funding a consensual Plan that is a negotiated, affordable and fair restructuring of Public Debt or the funding of a tender offer for those creditors who desire to exit the process. We must patiently await to see what this Congressional legislative year will bring from those involved. Congress has the constitutional mandate to accept the active guardianship role in decisions which will ultimately determine the fate of Puerto Rico and to be, for others, the good example for similar debt restructurings to come. This is not the time to let this ship run aground. Puerto Rico remains in troubled financial waters, and we need Congress now to do what it can do best and help steer the ship to a safe harbor that is hopefully the Rich Port.