Puerto Rico's Debt Crisis (Mar. 5)

Mike & Co. —

The February jobs report came out this morning better than expected.   Once again, the US economy maintained strong job growth without wage gains.  Wages fell 0.1 percent in February, but 242,000 positions were added to the economy, marking 72 months of uninterrupted job gains – the longest streak on record.

Additionally, labor participation rose by 1.5 million Americans since November – making it the highest it has been in 16 years (62.9 percent of the overall share of Americans).

The report from Puerto Rico is not as sunny.  The territory is still waiting on a Congressional bill designed to handle the ongoing debt crisis on the island.  More  below.

Best,

Dana

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Puerto Rico’s Time Bomb

The Puerto Rican debt crisis has been an ongoing concern for both Congress, Wall Street and the Obama administration for some years now – the territory’s bond ratings have been steadily dropping into the junk category and fell from A- in 2005 to CCC+ last April.  At the heart of the matter is $70 billion in bonds that Puerto Rico owes and says it cannot pay on.

Because Puerto Rican bonds are tax exempt in all 50 states and the District of Columbia, making them incredibly popular investments for mutual funds, pensioners, and big banks.  Over 20 percent of mutual funds in the United States hold at least some Puerto Rican bonds, with $11.3 billion in portfolio, with a further $15 billion in bonds held by hedge funds.  Now that the territory’s bonds are in the “junk” category, pension funds and insurance firms are unable to hold them any longer.

The diverse list of bond holders has thrown a wrench into the plans of those who would rather allow Puerto Rico to default on its obligations – something which would require legislative action (the territory doesn’t have that luxury, unlike states).  If Puerto Rico is allowed to renege on its contractual agreements, the argument goes, then it creates a moral hazard for other entities to do the same rather than make the tough choices necessary to honor their obligations.  The fact that many of these bonds are essentially held by ordinary Americans (through mutual funds and pensions) makes the argument all that stronger for many representatives.  A state hasn’t declared bankruptcy since Arkansas did so in 1933.

Moral hazard is inherent in a debt restructuring deal; here, the path for Puerto Rico toward capital markets after anything of the sort would still be an especially painful one (see: Argentina).  Additionally, there are few serious proposals to grant the island full Chapter 9 status.  Most opt instead for some form of negotiated haircut agreement combined with extending maturities on the bonds; these proposals are likely to succeed, considering Puerto Rico is almost certainly unable to maintain its bond payment schedule without a restructuring agreement.

Administration Position

Testifying before the House Committee on Natural Resources on Feb 25, Treasury official Antonio Weiss warned lawmakers that Puerto Rico needs “an immediate solution” if it’s to survive past May 1, when a $470 million bond payment is due.  Soon after that, on July 1, a $1.9 billion bond payment will come due as well – Puerto Rican representatives have already declared they cannot meet those payments without assistance.

Weiss laid out the administration’s two-part plan: first the territory must be allowed to restructure its debt obligations, second a fiscal oversight board should be established to assist the island with managing its finances.  Importantly, Weiss stopped short of advocating for bankruptcy protection for Puerto Rico and told the committee that “an advisory board is not adequate to do the job” alone.

House Democrats voiced concern over the financial oversight board, Rep. Luis Gutiérrez: “They’re saying that there’s a joint responsibility, but it seems to me that all of the responsibility is being weighed on the people of Puerto Rico.”

Meanwhile Republicans claimed that any plan to restructure Puerto Rican debt was a non-starter; a few hours after the hearing the Republican Study Committee announced it would oppose any plan including such a provision.  “Changing the rules mid-game would be unfair to Puerto Rico’s creditors who entered into these arrangements with agreed upon terms and would delegitimize future transactions,” said RSC Chairman Bill Flores.

Policy Options

Until recently the two parties have maintained starkly contrasting views on how to best deal with Puerto Rico’s debt crisis – Democrats have pushed for a forced debt restructuring, with some calling for the island to be granted Chapter 9 bankruptcy protections, meanwhile Republicans called for a financial oversight council to make the tough fiscal decisions necessary for Puerto Rico to maintain its debt obligations without reneging on its agreements.

The administration, through Weiss, has advocated a middle of the road approach. By adopting both proposals and avoiding the further edges of each (no bankruptcy, and no unaccountable board staffed by Wall Streeters), the administration hopes to find compromise between each group.  And it seems like it might work.

Finding Compromise

Recently, however, the conservative stance against debt restructuring has lessened – with some Republicans saying that they could support a PR bill as long as it doesn’t include Chapter 9 bankruptcy.  House Natural Resources chair Bob Bishop has been working on a bill for Puerto Rico that does include some element of debt restructuring, and recently said ““I’m sure RSC will be satisfied with what we do … to say that some element of [debt restructuring] could be in there, yeah.”
The House is still sticking to its end of March deadline set by Speaker Ryan for putting forward a final bill on Puerto Rico on the floor for a vote.

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