The endgame for Puerto Rico’s debilitating fiscal crisis has begun. Unable to manage a $74 billion debt that has accompanied a decade of recession, spikes in poverty, and a mass exodus of citizens, the island will now turn to federal courts to approve a resolution with its creditors.
But in many ways nothing has changed for Puerto Rico. The congressionally-imposed fiscal oversight board, known locally as the junta, remains in control as lead negotiator in restructuring talks. Whether Puerto Rico’s three million citizens get a fair deal or a continuation of harsh austerity depends almost entirely on seven unelected, unaccountable technocrats.
Frustrating journalists everywhere, what Puerto Rico did on Wednesday cannot be called “bankruptcy,” because Congressional Republicans who passed last year’s PROMESA law didn’t want to be saddled with such language. But the process under Title III of that law uses the Federal Rules of Bankruptcy Procedure to allow a court to administer and sanction restructured compensation for Puerto Rico’s creditors. Like a Chapter 9 bankruptcy, the judge can force bondholders to take a haircut, even if they don’t consent to the agreement. The result will amount to the largest-ever municipal not-bankruptcy bankruptcy in the United States.
But there are some key differences between Title III and a normal bankruptcy process. First of all, under Section 308(a) of PROMESA, the decision for who hears this case, bizarrely, is up to Chief Justice John Roberts. He selected U.S. District Court Judge Laura Taylor Swain to preside. While Swain has some experience in financial cases, including the prosecution of five former employees of Bernie Madoff, she's not a bankruptcy judge. And this puts the case in the heart of New York City, the nation's financial center, rather than Puerto Rico.
In addition, the elected government of Puerto Rico plays almost no role in this fight. The junta, an appointed body ushered in by PROMESA, actually filed the Title III order, and serves as the government’s “representative” in court. Only the junta can introduce or modify “adjustment plans” for the $73 billion in debts. They will be the sole negotiator with bondholders, not anyone approved by the Puerto Rican people through a formal vote.
Lawyers for bondholders have openly stated that the junta will enable them to win “fairer” outcomes in negotiations. In a little-noticed development, hedge fund creditors with constitutionally protected general obligation bonds reportedly had a deal nearly in place this week, but the junta intervened and stopped the talks. The Associated Press reported that the government offered general obligation bondholders 50 cents on the dollar, so that’s a benchmark we can use to assess the junta’s performance.
Furthermore, you cannot look at Title III in a vacuum. In March, the junta forced Puerto Rico into more austerity, a necessary condition of invoking the bankruptcy-like process. This blueprint added $39.6 billion in revenue hikes and budget cutbacks, some of them rather vicious, in particular hits to the health system and public education. Public pension spending must drop by 10 percent within three years, through a conversion to 401(k) plans from defined-benefit awards. Water rates must go up. Core government operations must be privatized. Furloughs starting July 1 must be initiated; the school year would be cut by two months as a result.
This savagery was required under PROMESA before triggering Title III. Activists have protested forced austerity for months, blaming the junta for prolonging the pain. On May Day, police broke up demonstrations with tear gas. Professionals continue to abandon the island, particularly medical students. And nothing the junta has instituted thus far has done anything for the island economy; Puerto Rico’s 12 percent unemployment rate has worsened every month for over four years, and those numbers have not improved since the junta took over.
Even still, the austerity plan only allocated $800 million a year for debt service, far below the $3.5 billion owed. This angered bondholders and collapsed debt talks, leading to the invocation of Title III.
Remember that many vulture investors scooped up tax-exempt Puerto Rican debt at severe discounts, expecting a giant payday. But mutual funds who purchased debt at par, or bond insurers who pay off creditors who lose money, have far less room for error. One of them, Assured Guaranty, already sued the junta on Thursday, challenging the low annual allocation for Puerto Rican debt service.
We don’t know what Title III will really mean for creditors. Judges typically have wide discretion to alter terms in bankruptcy. General obligation bondholders, who almost inked a settlement with the Puerto Rican government, seem irritated by Title III, while bondholders of debt backed by sales taxes seem happier. Whatever the outcome, it’s likely to be protracted: lawsuits over Title III cannot be filed for 120 days, and the overall process could take years.
However, according to PROMESA, courts can only confirm a restructuring plan if it is “feasible” and “in the best interests of creditors.” The judge will have to consider other options that “would result in a greater recovery for the creditors.” In addition, creditors’ “lawful priorities or lawful liens” must be respected.
How is Puerto Rico protected? PROMESA says the ultimate fiscal plan must “provide adequate funding for public pension systems,” but there’s no definition of adequacy. Also, the court cannot “interfere with … the property or revenues of the debtor,” with one caveat—the junta’s consent.
It’s completely unclear how these components of the law will be applied. But they could frustrate legitimate help for Puerto Rico. In other words, this game could be rigged. It’s telling that bond prices on Puerto Rican debt barely budged after the Title III announcement.
So much of the island’s fate depends on the bargain the junta decides to drive. Junta members have continued to say that they’d prefer an out-of-court settlement, undermining the leverage of the Title III process. And several of them served as executives for Santander Bank, which underwrote most of the bonds for the island, facilitating the debt crisis. Whose interests they have at heart, Puerto Rican citizens or the moneymen, will be revealed in this process.
To be clear, the junta didn’t design the Title III process themselves. The Republican Congress—heavily lobbied by financial interests—engineered the loss of sovereignty, bias toward austerity, and questionable restructuring rules in PROMESA, and President Obama validated it with his signature. While $295 million in this week’s omnibus spending bill to replenish Puerto Rico’s Medicaid fund will help avert disaster, it amounts to a fraction of the help needed, and the only dollars ever requisitioned for the island throughout this entire ordeal.
In effect, the island has gone from a political form of colony to an even deeper economic colonialism, in which its fate is the hands of distant fiscal masters.
Since passage, lawmakers from both parties have insisted that PROMESA reflected the best they could possibly do to prevent chaos in Puerto Rico. Over the next couple years, we’ll get to see what that looks like: will it be a lifeline for the commonwealth, or more like the ravaging of Greece by the EU and the IMF? I’m not looking forward to learning the answer, nor should any Puerto Rican.