Why Puerto Rico’s super restructuring is bad policy

Last week, Congress unveiled a dubious “solution” to Puerto Rico’s staggering fiscal crisis: a precedent-setting legislative package that promises to both disrupt the municipal market and violate the U.S. Territory’s constitution – all while providing little meaningful assistance for the island or its people.
 
Utah Congressman and House Natural Resources Committee Chairman Rob Bishop has proposed a draft bill that aims to circumvent long-established legal norms. Under this new legal framework, bondholders and the Puerto Rican government must submit bond payments in question to oversight by a five member board appointed by the President.
 
{mosads}This new control board has the power to audit the island’s government, force budget cuts, and determine what how much of the territory’s $72 billion debt must be restructured. In fact, this board can even authorize a complete and indiscriminate restructuring of Puerto Rico’s debts, including those that, until now, were structured to be non-negotiable.
 
The bill goes even further, both offering the control board a cramdown mechanism to force creditors to accept restructuring proposals and implementing a wholly-unprecedented stay on all creditor legal actions, which all but ensures that Puerto Rico will walk away from the negotiating table.
 
This proposed regime is as aberrant as it is counterproductive. First, this setup violates Puerto Rico’s own constitution. Specifically, Article VI, Section 8 states, “interest on the public debt and amortization thereof shall first be paid and must be serviced by the government prior to any other government obligation.” Under the rationale that U.S. law trumps Puerto Rico’s, the island’s Governor Alejandro García Padilla views federal action as a loophole that permits him to circumvent his constitutional obligations. He claims that without drastic action, “we will be in a death spiral.”
 
Second, the proposed regime threatens to force bondholders to accept less than they are entitled to under the bonds’ terms. In other words, the federal government would be seeking to compel private parties to mediate this dispute – potentially subjugating the rule of law to political expediency.
 
Third, the legal stay, which differs significantly from stays enacted under regular Chapter 9 because there are no accompanying rules about how Puerto Rico can pay creditors or use resources, all but guarantees that the legislation undermines the Committee’s own stated goals of promoting good-faith negotiations and avoiding complicated litigation.
 
Compounding matters further, the U.S. Treasury has sought to disregard bankruptcy law’s long-established seniority structure. When lending, creditors rely on the hierarchy of debt to evaluate risk and rates. Senior creditors get paid first, while more junior creditors run a higher risk in the event of default, so they charge higher interest for that added risk. This certainty is a bedrock upon which municipal lending is built.
 
In fact, even in Greece’s chaotic 2012 default, it repaid senior creditors – the World Bank and International Monetary Fund – first, before turning to more junior bondholders.
 
But Governor Garcia Padilla, along with Treasury Counselor Antonio Weiss, are seeking to ignore this hierarchy and shred the sanctity of general obligation debt. If this remains in the final plan lawmakers adopt, it not only will rock municipal lending markets generally, but, in Puerto Rico’s specific case, would also serve as a grave impediment to the territory’s obtaining vital liquidity in the future, no matter how senior the debt.
 
The more advantageous approach to remedy Puerto Rico’s spiraling financial woes would be to tie necessary financial reforms to strategically pinpointed relief, all while ensuring that the island works with creditors to fulfill its “full faith and credit” obligations – and on down the hierarchy to the extent feasible.
 
Instead, this plan will serve to protect the existing politicians, drive up Puerto Rico’s future borrowing costs, compromise ongoing good-faith negotiations, and maintain the island’s dependence upon the United States as we wait for the next crisis to build.
Congressional leaders must understand that Representative Bishop’s plan threatens to disregard property rights in favor of a nostrum – one that will help make Puerto Rico’s debt death spiral perpetual.

Logan Beirne is and ISP Fellow & Lecturer in Law at Yale Law School, where he teaches Financial Markets and Corporate Law. He is the author of “Blood of Tyrants: George Washington & the Forging of the Presidency.”