Obama’s radical proposal for Puerto Rico’s debt
Puerto Rico’s debt crisis exploded into view at the end of June, when Governor Alejandro García Padilla revealed that the island’s fiscal situation was so bad it wouldn’t be able to repay the $73 billion it owed to bondholders.
The unexpected statement sent Congress scrambling for a solution, and since then, the debate has centered on whether Puerto Rico’s public corporations, like utilities—which hold a significant amount of its debt—should be allowed to declare chapter 9 bankruptcy, an option available in all 50 U.S. states, but not in Puerto Rico. Both Jeb Bush and Hillary Clinton have expressed support for the idea. In July Senators Richard Blumenthal (D-Conn.) and Chuck Schumer (D-N.Y.) introduced a chapter 9 law for Puerto Rico, and the Senate Finance Committee held a contentious hearing on the island’s finances in September.
This week the Obama administration weighed in with its own plan, and it’s considerably more radical.
In a 10-page document issued Wednesday night, it proposed allowing Puerto Rico itself to go through bankruptcy and restructure its bonds. This is an option no U.S. state enjoys.
“It would be unprecedented in the American context,” said Robert Shapiro, the former undersecretary of commerce for economic affairs. “We don’t have a provision for states going bankrupt.”
There’s one big argument for doing this: Puerto Rico’s economic malaise makes its debt unpayable. Puerto Rico’s economy has been contracting for nearly a decade straight and its population has been fleeing to mainland United States, eroding its tax base. That makes it all but impossible for the government to provide adequate services to its residents and pay its creditors in full—and may require an extreme measure to help it get out from under.
The White House’s proposal immediately drew fire, and not just from the bondholders who would lose money under the deal. “I think it makes no sense,” Luis Fortuño, the former governor of Puerto Rico, said in an interview.
Fortuño has been a strong voice in favor of giving chapter 9 protection to the island, but worries that this new proposal—so-called “super chapter 9”—goes too far. “It could be viewed as a precedent,” he said. “And the question a number of people would ask [is] if the territories can have a super chapter 9, why not Illinois or California?”
Financially, the bankruptcy debate really boils down to borrowing costs. Because states legally can’t go bankrupt, they can issue bonds more cheaply, since it’s less risky to underwrite them. If there were some kind of precedent—just a hint—that state bankruptcy might be possible, borrowing costs could go up for everyone.
The White House tried to preempt that problem by noting that “this framework should be reserved exclusively for U.S. territories.” So, theoretically, Guam or American Samoa could go bankrupt, but not Ohio or Virginia. But there’s nothing binding about such a statement; spooked bondholders could well demand higher borrowing costs anyway.
Legally, experts say that whole idea is so novel that it’s impossible to know the implications. Law professors say it may well be unconstitutional for states to go through bankruptcy, but it’s uncharted territory.
“States have residual sovereignty in our system, distinct from the federal government, and it's not clear how that works in a federal bankruptcy proceeding,” said Stephen Lubben, a law professor at Seton Hall focusing on corporate restructuring and financial distress.
For capital-watchers, the proposal came with one more intriguing twist: its architect is Antonio Weiss, the former Wall Street banker whose nomination for the number three position at Treasury was publicly torpedoed by Sen. Elizabeth Warren (D-Mass.). Since then, Obama appointed him as a Treasury counselor, effectively giving him the same role without the need for Senate confirmation. On Thursday, the Senate Energy and Natural Resources Committee held a hearing on Puerto Rico’s finances, and Warren took the chance to harangue Weiss over her concerns that Treasury was not doing enough to help Puerto Rico.
“Let me assure this committee that Treasury and the broader administration will apply all of its efforts and all of our creativity and all our resources to the resolution of this financial crisis,” Weiss responded, “just as we have in past crises, and we will leave no stone unturned.”
As for Puerto Rico itself, “super chapter 9” would likely raise its borrowing costs, although it’s unclear how much. Critics suggest that restructuring constitutionally guaranteed debt—officially called general obligation bonds—could cause investors to flee the island and set back its growth prospects.
“If they can sweep away that kind of constitutional guarantee and do it retrospectively, why would any foreign investor want to go to Puerto Rico?” said Shapiro, who supports normal chapter 9 for Puerto Rico. But legal experts aren’t convinced, suggesting the island’s borrowing costs may rise in the short-term but could be fine over the long-term, especially since the administration’s proposal also asks Congress to provide independent fiscal oversight over the government’s finances.
Also at Thursday’s hearing was Pedro Pierluisi, the island’s one non-voting representative in Congress, who made an impassioned statement that the true root of Puerto Rico’s problems lies with its second-hand status, governed by Congress’s laws without any say in them. And that speaks to the ultimate irony of “super chapter 9”: Puerto Rico may be eligible for it precisely because of its second-hand status.
“This is obviously a bit of a setback [for getting statehood] for them if they go this route,” said Lubben. “The ability to do this for me hinges on that they’re not a state.”
“It would be unprecedented in the American context,” one expert says.
By Danny Vinik
Obama’s radical proposal for Puerto Rico’s debt
The unexpected statement sent Congress scrambling for a solution, and since then, the debate has centered on whether Puerto Rico’s public corporations, like utilities—which hold a significant amount of its debt—should be allowed to declare chapter 9 bankruptcy, an option available in all 50 U.S. states, but not in Puerto Rico. Both Jeb Bush and Hillary Clinton have expressed support for the idea. In July Senators Richard Blumenthal (D-Conn.) and Chuck Schumer (D-N.Y.) introduced a chapter 9 law for Puerto Rico, and the Senate Finance Committee held a contentious hearing on the island’s finances in September.
This week the Obama administration weighed in with its own plan, and it’s considerably more radical.
In a 10-page document issued Wednesday night, it proposed allowing Puerto Rico itself to go through bankruptcy and restructure its bonds. This is an option no U.S. state enjoys.
“It would be unprecedented in the American context,” said Robert Shapiro, the former undersecretary of commerce for economic affairs. “We don’t have a provision for states going bankrupt.”
There’s one big argument for doing this: Puerto Rico’s economic malaise makes its debt unpayable. Puerto Rico’s economy has been contracting for nearly a decade straight and its population has been fleeing to mainland United States, eroding its tax base. That makes it all but impossible for the government to provide adequate services to its residents and pay its creditors in full—and may require an extreme measure to help it get out from under.
The White House’s proposal immediately drew fire, and not just from the bondholders who would lose money under the deal. “I think it makes no sense,” Luis Fortuño, the former governor of Puerto Rico, said in an interview.
Fortuño has been a strong voice in favor of giving chapter 9 protection to the island, but worries that this new proposal—so-called “super chapter 9”—goes too far. “It could be viewed as a precedent,” he said. “And the question a number of people would ask [is] if the territories can have a super chapter 9, why not Illinois or California?”
Financially, the bankruptcy debate really boils down to borrowing costs. Because states legally can’t go bankrupt, they can issue bonds more cheaply, since it’s less risky to underwrite them. If there were some kind of precedent—just a hint—that state bankruptcy might be possible, borrowing costs could go up for everyone.
The White House tried to preempt that problem by noting that “this framework should be reserved exclusively for U.S. territories.” So, theoretically, Guam or American Samoa could go bankrupt, but not Ohio or Virginia. But there’s nothing binding about such a statement; spooked bondholders could well demand higher borrowing costs anyway.
Legally, experts say that whole idea is so novel that it’s impossible to know the implications. Law professors say it may well be unconstitutional for states to go through bankruptcy, but it’s uncharted territory.
“States have residual sovereignty in our system, distinct from the federal government, and it's not clear how that works in a federal bankruptcy proceeding,” said Stephen Lubben, a law professor at Seton Hall focusing on corporate restructuring and financial distress.
For capital-watchers, the proposal came with one more intriguing twist: its architect is Antonio Weiss, the former Wall Street banker whose nomination for the number three position at Treasury was publicly torpedoed by Sen. Elizabeth Warren (D-Mass.). Since then, Obama appointed him as a Treasury counselor, effectively giving him the same role without the need for Senate confirmation. On Thursday, the Senate Energy and Natural Resources Committee held a hearing on Puerto Rico’s finances, and Warren took the chance to harangue Weiss over her concerns that Treasury was not doing enough to help Puerto Rico.
“Let me assure this committee that Treasury and the broader administration will apply all of its efforts and all of our creativity and all our resources to the resolution of this financial crisis,” Weiss responded, “just as we have in past crises, and we will leave no stone unturned.”
As for Puerto Rico itself, “super chapter 9” would likely raise its borrowing costs, although it’s unclear how much. Critics suggest that restructuring constitutionally guaranteed debt—officially called general obligation bonds—could cause investors to flee the island and set back its growth prospects.
“If they can sweep away that kind of constitutional guarantee and do it retrospectively, why would any foreign investor want to go to Puerto Rico?” said Shapiro, who supports normal chapter 9 for Puerto Rico. But legal experts aren’t convinced, suggesting the island’s borrowing costs may rise in the short-term but could be fine over the long-term, especially since the administration’s proposal also asks Congress to provide independent fiscal oversight over the government’s finances.
Also at Thursday’s hearing was Pedro Pierluisi, the island’s one non-voting representative in Congress, who made an impassioned statement that the true root of Puerto Rico’s problems lies with its second-hand status, governed by Congress’s laws without any say in them. And that speaks to the ultimate irony of “super chapter 9”: Puerto Rico may be eligible for it precisely because of its second-hand status.
“This is obviously a bit of a setback [for getting statehood] for them if they go this route,” said Lubben. “The ability to do this for me hinges on that they’re not a state.”
“It would be unprecedented in the American context,” one expert says.
By Danny Vinik
Obama’s radical proposal for Puerto Rico’s debt
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