For Puerto Rico debt crisis, the can hits the end of the road

Confronting problems is painful politically, and so kicking such cans down the road is a Beltway tradition. Why endure pain in the here-and-now when delay is an option that just might dump the given problem onto the next incumbent?

{mosads}A good question indeed. But a better one is: Given that not all policy interventions prove advantageous on net — I betray no secret when I report that policymakers often get things wrong — might not can-kicking into the future sometimes be better than dubious “solutions” adopted under the pressures of the moment?

Well, yes; the absence of government action can be better than ill-advised government action. The latest illustration of this eternal truth is Senate Bill 1774, which would amend federal law to make Puerto Rico government corporations eligible for Chapter 9 bankruptcy retroactively.

A bit of background: Puerto Rico is the third-largest issuer of municipal bonds in the U.S., with debt now totaling about $73 billion. Legislation enacted by Congress in 1984 prevented it and its various municipal agencies and bureaus from using Chapter 9. That has had the effect of reducing the interest rates that they have had to pay because purchasers of the bonds had greater resulting confidence in repayment. Moreover, Puerto Rico and its various borrowing units have been granted a nationwide tax exemption for their bonds — a preference bestowed upon no U.S. state — thus reducing Puerto Rico’s borrowing costs even more.

And the proscription of Chapter 9 bankruptcy has yielded a broader benefit: It creates efficient incentives for public officials because they have political time horizons — the next election — shorter than the economic horizons shaping business decisions. Municipal debt crises would have adverse effects down the road, but those would be borne by future officeholders rather than those currently incurring too much debt. The prohibition on municipal bankruptcy imposes a useful constraint in the here-and-now.

So S. 1774 would change the rules of the game after it has been played. Sadly, there are no free lunches: Because retroactive bankruptcy would violate past lending agreements, Puerto Rico’s future borrowing costs would rise due to the obvious increase in perceived risks, both from the narrow threat of bankruptcy and from the larger increase in the likelihood that agreed contractual terms might not be treated as actual commitments. And Puerto Rico’s borrowing needs over the not-distant future are substantial. The Puerto Rico Electric Power Authority (PREPA) alone will need to make large investments in equipment and infrastructure in order to satisfy new environmental requirements now being finalized by the Environmental Protection Agency (EPA), and to move away from the use of expensive oil. The Puerto Rico Aqueduct and Sewer Agency — the debt of which already is below investment grade — has investment needs over the next few years of well over $1 billion, of which about $400 million alone is needed to satisfy consent decrees with the EPA. And so on.

Nor would this adverse long-term effect be limited to Puerto Rico. If the commonwealth’s commitments can be repudiated after the fact, why not erode other debts incurred by other borrowers in the municipal bond market? If enacted, S. 1774 promises to increase borrowing costs for all municipal debt across the country, an outcome that would serve the interests of no one except borrowers with political incentives to acquire debts that cannot be sustained.

Back to Puerto Rico: Whatever the merits of past borrowing decisions, the crisis has arrived. The Public Finance Corporation, a subsidiary of the Puerto Rico Government Development Bank, failed to make a $58 million bond payment due on Aug. 3. Gov. Alejandro García Padilla on Dec. 1 announced that henceforth debt payments will be made only on bonds backed by the “full faith and credit” of the commonwealth, beginning with payment of $354 million; but that such payments moving forward would be financed by withholding payments on bonds with lesser guarantees, possible examples of which are highway and other infrastructure bonds.

That Puerto Rico officials are desperate for retroactive access to Chapter 9 is obvious; that would make negotiations with creditors far easier. At the same time, it would weaken pressures for needed policy reforms, as a summary review of the recent bankruptcy for Detroit — often described as “successful” — demonstrates. Pension costs were the single largest outlay in the city budget, but the bankruptcy in effect reinstated pension obligations in full while bondholders received less than 10 percent of what was owed them. City officials were able to avoid the adoption of almost all major cost efficiencies, such as those recommended for the Department of Transportation. Not one of Detroit’s 28 agencies was closed. Infrastructure planning has not been adjusted to reflect a population decline of almost two-thirds. And so on.

In short: A retroactive resort to Chapter 9 will penalize those not responsible for the fiscal problems confronting Puerto Rico, will increase future borrowing costs for the municipal bond market writ large, and will weaken incentives to adopt fiscal and governance reforms. And it is not as if Puerto Rico is unable to negotiate with its creditors: PREPA’s creditors have agreed to accept substantial reductions in their repayments, reduced interest rates on what is owed and a deferment of principal payments.

In short: The Senate should kick the can down the road by not passing S. 1774; the parties can work this out without the adverse effects of Chapter 9. But Congress can do some things that will facilitate economic growth in Puerto Rico, examples of which are an elimination of Jones Act requirements for the use of U.S.-flagged vessels for transport services to the island, and an elimination (or reduction) of the minimum wage, the effect of which is to increase unemployment. Such are the real reforms that Congress should consider as the Puerto Rico debt crisis commands attention.

Zycher is the John G. Searle scholar at the American Enterprise Institute.