Diary

Puerto Rico Bankruptcy is a Key Test of Republican Congressional Leadership

Puerto Rico seeks to address their financial crisis with bankruptcy
Puerto Rico seeks to address their financial crisis with bankruptcy

Once again Republican leadership will be tested and they will show whether they cave in to political expediency or uphold the basic conservative principles on which the American people elected them to their offices. Congress may soon decide whether or not Puerto Rico and its state run enterprises will be given bankruptcy protection under Chapter 9, and Republicans in Congress can send a clear message in favor of fiscal responsibility by rejecting the call for bankruptcy protection and causing the Commonwealth of Puerto Rico to implement governmental and fiscal reforms that will fix the root causes of the crisis that causes them to demand remedy via bankruptcy.

Puerto Rico’s largest electric provider, the state-run Puerto Rico Electric Power Authority (PREPA) has come begging to Congress for Chapter 9 bankruptcy protection, revealing that they expect to be unable to pay about $1.13 billion in debt it owes between now and the end of June later this year. PREPA faces financial obligations two times their cash on hands, and is asking Congress to grant them bankruptcy protection.

The House Natural Resources Committee heard the issue earlier this week, as representatives of PREPA requested bankruptcy protection. At the same time, the government of Puerto Rico defaulted on more than $37 million of bond payments this month. Also, the Commonwealth struggles with $70 billion of debt from years of borrowing. Compared to other states and territories, Puerto Rico is by far more in debt than any others. The Commonwealth’s governor, in July of last year, announced that Puerto Rico’s debt is “unpayable.”

Puerto Rico has incurred a per capita debt of $15,637, which is 10 times higher than the average per capita debt of the 50 states, according to Moody’s. This includes all of Puerto Rico’s debt, except that of PREPA, it’s largest electric utility. In comparison, the state of Connecticut has $5,491 per capita debt, the highest of the 50 states. Nebraska is the lowest of the 50 states, with $10 per capita debt. Puerto Rico’s public debt reached 87.5 percent of personal income in 2013, compared with an average of 3.1 percent among the 50 states. The debt is 26.8 percent of revenue, more than double Hawaii’s debt of 13.0 percent of revenue, while the mean of the 50 U.S. states is debt comprising 5.5 percent of revenue. Puerto Rico is reaching a level of debt that might not be sustainable.

The Commonwealth’s government has hired former Judge Steven W. Rhodes and Richard Ravitch, who both advised the city of Detroit on their bankruptcy, as advisors on bankruptcy. Ravitch, who sits on the board of the Build America Mutual, and the Volcker Alliance (which has been the source of misinformation published via Bloomberg News), which holds no interest in Puerto Rico, would benefit from causing competitors to incur losses in Chapter 9 bankruptcy.

The government of Puerto Rico defaulted on payment of $58 million of moral obligation bonds, citing insufficient liquidity to make the payment, in a move that was seen as public relations in building their case for bankruptcy. The Commonwealth’s government made the question argument that it was not required to make the bond payment because it was not required to provide a budget appropriation for the payment.

The U.S. Department of Justice notified the Commonwealth that eight of its state-run entities were “high-risk grantees,” raising serious questions about the administration of funds by state-run enterprises of Puerto Rico. Days later, on August 21 of last year, the government of Puerto Rico appealled to the U.S. Supreme Court to overturn a lower court ruling on the Recover Act, just days before Puerto Rico Aqueduct and Sewer Authority (PRASA) was to close on a $750 million bond offrering, which was cancelled amid the push for bankruptcy.

In response to all this bad economic news, the government of Puerto Rico has sought to spin the situation by releasing misleading reports about the Commonwealth’s financial situation. In September of last year, the government released its Fiscal Economic Growth Plan (FEGP) prepared by Millstein and a Liquidity Update prepared by Conway McKenzie. The FEPG provided 5-year projections on a subset of government entities with no reconciliation to historical financial information. The projections painted a dire picture by showing a decline in revenue and a significant increase in expenditures, including capital expenditures on strategic infrastructure investments. The projections showed no new government measures that materially increase government revenues or reduce expenditures. Creditors generally found the FEPG and Liquidity Update to be misleading and published to support the government’s lobbying effort for Chapter 9.

The government of Puerto Rico prevents information from getting out by coercing creditors into signing non-disclosure agreements (NDA) preventing them from disclosing and sharing information. Puerto Rico has yet to file audited annual statements for the year ending June 30, 2014, nor has it explained why historical financial information for any of its entities should proprietary or confidential. The only reason given is about controlling the messaging.

Puerto Rico’s failure to negotiate restructuing of $5 billion of bonds issued by the Government Development Bank (GDB) appears to be another failure designed to prove that Puerto Rico needs Chapter 9 bankruptcy protection. The government has also failed to comply with its constitutional requirement to balance its budget in five of the last six years, and has failed to do so in 14 of the last 15 years, while incurring a cumulative deficit (government revenues less expenditures) of $8.6 billion.

While more than three-quarters of Puerto Rico’s debt will not qualify for Chapter 9 bankruptcy protection as made available for U.S. states, the government is seeking bankruptcy powers that exceed those given to U.S. state. Puerto Rico is seeking Chapter 9 protection that would allow it to impair general obligation bonds and allow as much as half of its debt to qualify.

Granting Puerto Rico bankruptcy protection under Chapter 9 will only reward the government for their poor financial performance and enable them to keep spending out of control running inefficient and corrupt state-run enterprises. The better course of action for the Commonwealth would be to skip the bankruptcy and implement a comprehensive set of governmental and financial reforms to improve economic performance and grow their economy.

Congress should resist the temptation to approve bankruptcy protection, and instead should advise the Commonwealth to seek a path of reform that would address the root causes of the current crisis, fix those causes, and prevent any future need for bankruptcy for Puerto Rico. If the Republican majority, not to mention the Democratic minority, of Congress truly believes in fiscal responsibility and economic growth, denying Puerto Rico’s request for bankruptcy will be a great opportunity to demonstrate a strong stance for principle over political expediency.