Relief for debt-burdened Puerto Rico could be on its way – members of the U.S. House of Representatives this week announced that they have crafted a bipartisan agreement on legislation that would allow the island to essentially declare bankruptcy and get relief from the more than $70 billion the U.S. territory owes bondholders.
Under the deal, Puerto Rico’s creditors would receive less than 100% of what they are owed, but it would also mean they wouldn’t have to enter into potentially costly litigation to try to get their money. The House is expected to vote on the legislation in June. The deal would also come with the stipulation that a control board appointed by Congress and the President will oversee some of the debt restructuring. Puerto Rico would also have to provide the control board with budgets and a plan to achieve fiscal responsibility, The Associated Press reported. The legal framework established by the bill would be similar to Chapter 9 bankruptcy, but also address some issues that have caused creditors to believe that the island’s filing for Chapter 9 would stack the odds against them. U.S. bankruptcy code currently bars Puerto Rico from seeking such debt relief.
Puerto Rico has already missed three payments on its debt, including an almost $400 million payment that was due this month, and a nearly $2 billion payment is looming in July. Puerto Rico Governor Alejandro Garcia Padilla says that his government most likely won’t be able to make that one, either.
Will the bondholders lose their shirts, take a haircut, or somehow be made whole? And when it’s all over, who will be in charge of rebuilding the island’s economy? David Skeel, a professor of corporate law at the University of Pennsylvania Law School, joined the Knowledge at Wharton radio show on Wharton Business Radio on SiriusXM earlier this month to explain how Puerto Rico wound up in such a deep economic pit in the first place, to discuss the options on the table for digging it out, and to consider what changes need to be made so that a similar crisis doesn’t crop up in the future.
You can listen to the interview using the player above. An edited transcript of the conversation appears below.
Knowledge at Wharton: Let’s start with a look back at what has happened, the money that is still owed, and why this has all happened, and why this continues to happen. What’s your viewpoint?
David Skeel: On the question of how we got here, as is always the case, it’s overdetermined. Lots of different things happened to send Puerto Rico into a tailspin. One of the things that happened was Puerto Rico had a big tax break for manufacturers who came to Puerto Rico. Pharmaceutical companies in particular took advantage of that. That tax break was phased out starting in the late 1990s, and finally phased out, I believe, in 2006, and a lot of that industry left. So that was one of the problems. They’ve had employment problems generally. They ended up, over the last 10 years or so, funding government operations with debt. There are some other factors as well, but those are some of the big pieces of their problem.
Knowledge at Wharton: One question that has been brought up is whether or not — even though Puerto Rico is a territory — it should have the ability to file for Chapter 9 bankruptcy. What’s your opinion?
Skeel: Well, I think they should. Many people think they should. Not everybody thinks they should. As most people who are listening will know, Chapter 9 allows municipalities in states that permit Chapter 9 to file for bankruptcy. Puerto Rico was excluded from this in 1984. So Puerto Rico’s municipalities cannot file for bankruptcy.
In my view, Puerto Rico and its municipalities ought to be able to file for bankruptcy. But there’s lots of opposition to that. Some people would be OK with Chapter 9 for Puerto Rico’s municipalities, but not for Puerto Rico itself. Some people don’t want either, some people want both.
Knowledge at Wharton: Is it just the fact that it’s a territory that is really holding back the government from designating Chapter 9 as a possibility for Puerto Rico?
Skeel: Historically, yes. If Puerto Rico was a state, or had become a state, there’d be no question about the ability of its municipalities to file for bankruptcy. Now, there would be a question whether that’s enough. A large share of Puerto Rico’s debt is either directly or indirectly owed by the territory itself. So some people — including me — think that Puerto Rico needs to be able to file for bankruptcy. But putting that to one side, it’s clear that the island’s municipalities would be able to file for bankruptcy if Puerto Rico was a state. But this is something that it lost out on, because it’s not.
Knowledge at Wharton: Did it surprise you at all that they knew that they were not going to be able to make the $400 million payment earlier this month? And now, they’re already saying the next payment is not going to be there as well.
Skeel: It’s not too much of a surprise. The governor’s been making it clear since December that these are the big obstacles. Puerto Rico had missed some small payments several months ago. But what everybody said was, the big payment in May, the big payment in July — those are the ones Puerto Rico just cannot make. And Puerto Rico has kind of committed itself to that position, saying, “We can’t make it, and we’ve missed the first one.” And it looks like they will miss the July one as well.
“You hear words like ‘colonialism’ and ‘imperialism’ thrown around, and those words look to be lines drawn in the sand. But it’s hard to know just how staunch the resistance will be, when push comes to shove.”
Knowledge at Wharton: What would you like to see happen over the next few months to try to alleviate the financial burdens the Puerto Rico is dealing with? And even more so, how would you recommend setting up a structure for this government and this economy so that we’re not talking about this constantly, or even once again in five to 10 years?
Skeel: In my view, there are two things that need to be done. And I’m putting aside the things that need to be done to make growth possible for Puerto Rico — there are a variety of things there as well. There are issues about the minimum wage. There are issues about Medicaid payments to Puerto Rico. I’ll just push those to one side, and focus on getting the core of Puerto Rico in shape.
The two things Puerto Rico needs, in my view: The first thing they need is a financial control board. A board that would come in the way boards came in in Washington, D.C., in the 1990s, or in New York in the 1970s, and be given fairly extensive powers to fix the budget, to prepare a five-year plan for Puerto Rico’s future, and to basically get the government in order. You don’t get into this kind of financial trouble without having governance problems — without having dysfunctional government.
The second thing is debt relief. In my view, what they need is Chapter 9 bankruptcy, or its equivalent. This could also be done through the Territories Clause of the United States Constitution. There could just be a territory restructuring law. In my view, there needs to be that as well. As I’ve already said, I think Chapter 9 needs to be available not just for the municipalities, but for Puerto Rico itself as well. Puerto Rico has $72 billion in debt now. That’s more than their GDP. They just can’t pay it all.
Knowledge at Wharton: In some respects, it’s a little disappointing — though maybe not surprising — that we haven’t seen more done on this faster, involving the federal government.
Skeel: I agree completely. If this were a state, I think a lot more would have been done a long time ago. But because it’s a territory, it is not in people’s viewing horizon. It just hasn’t gotten the attention it should. But that’s a mistake. Puerto Rico’s citizens are U.S. citizens. And what is happening as a result of this financial catastrophe is that many of them are coming to the United States. There are hundreds of thousands of Puerto Rican citizens in Florida. There are something like 300,000 here in Pennsylvania. So even if people aren’t paying attention now, sooner or later, they’re not going to have any choice.
Knowledge at Wharton: In terms of a financial control board, is the government of Puerto Rico ready to give over that type of control?
Skeel: There’s a lot of resistance to it in Puerto Rico. The exact level of resistance depends on how strong of a control board it would be. One proposal that was made by a group of Democratic senators calls for a control board that would be largely controlled by Puerto Rico officials themselves. Puerto Rico’s OK with that.
They are not nearly as OK with the Natural Resources Committee’s bill, which proposes a much stronger control board, one that looks like the one that was used in Washington, D.C., in the 1990s. There’s a lot of resistance to that. You hear words like “colonialism” and “imperialism” thrown around, and those words look to be lines drawn in the sand. But it’s hard to know just how staunch the resistance will be, when push comes to shove.
Knowledge at Wharton: What has been the reaction of the people of Puerto Rico to all of this? Because the government is supposed to be taking their thoughts into consideration, and trying to work off of what the people want. Are the people being heard?
“What they need is Chapter 9 bankruptcy, or its equivalent. This could also be done through the Territories Clause of the United States Constitution.”
Skeel: My one-word description of their reaction, I think, would be “complicated.” They feel like they ought to be helped. But there is a fair amount of resistance to the idea of a control board, and the U.S. Congress coming in, and as it’s often perceived, taking over the government in Puerto Rico. So, there’s that factor.
It’s also the case that a fair number of Puerto Rico’s citizens hold Puerto Rico bonds, and Puerto Rico debt. From their perspective, they’re concerned about a restructuring. They don’t want a restructuring. So I think I would say that my understanding is that the mood on the ground is anxious, angry and complicated.
Knowledge at Wharton: And the value of those bonds, each and every day that this process is going on, is …?
Skeel: It’s dropping. And in fact, even the most well secured bonds — Puerto Rico issued a lot of general obligation debt that is guaranteed by the Constitution — I think they’re selling at about 70 cents on the dollar right now. And those were thought to be bulletproof. And it goes down from there.
Knowledge at Wharton: What is the expectation of Wall Street in all of this? Because these bonds are losing a lot of value.
Skeel: Wall Street expects that the bondholders are not going to get 100 cents on the dollar. And that’s why they’re trading, for even the secure ones, at 60 and 70 cents on the dollar.
Knowledge at Wharton: At this point, should there even be an expectation of getting close to an even value?
Skeel: I don’t think there should. But it’s still unclear what the endgame is. There are a variety of different possibilities. One is you get a restructuring option, and they’re written down. Another is you don’t get a restructuring option, and Puerto Rico just doesn’t pay. They just collapse. Another is you don’t get a restructuring option and somehow Puerto Rico pays. They get a bailout from the U.S., or they find some money that nobody knew was around until then. And there are some who are still holding out hope that they’ll be bailed out, or paid in full. But I think the overall sentiment is, it’s a mess. People are not going to get 100 cents on the dollar. The question is, how we get to where we get.
Knowledge at Wharton: Are there other financial markets around the globe that are potentially willing to take on some of this debt at this point? They obviously are going to see what Wall Street is seeing, and probably step back from Puerto Rico’s debt as well.
Skeel: That’s right. And that’s one of the main points that Wall Street has been making. Wall Street, particularly the people who think Puerto Rico doesn’t, at the end of the day, have to restructure its debt, are saying, “Puerto Rico, if you don’t pay your debt in full, you’re never going to be able to borrow again.” And there is a real question about Puerto Rico’s ability to go back to the debt markets. But the thing to keep in mind is, we’re already there: Puerto Rico already can’t go to the debt markets, short of a bailout, a parachute or a helicopter drop from Washington of about $5 billion or $6 billion, so there’s going to be some pain in the bond markets. I think a restructuring actually would make it better. It would provide an orderly resolution to this, rather than the water torture that Puerto Rico is going through right now.
“The short-term time frame is that big July payment that comes due. I think right now, people are looking at that as the guillotine.”
Knowledge at Wharton: You also mentioned in an article you did for the Public Policy Initiative here, the unemployment problem in Puerto Rico right now. In the United States, economists view it as disappointing that the labor participation rate is in the low 60% range — it’s 62.5% right now. In Puerto Rico, it’s not even above 50% at this point, correct?
Skeel: Depressing is the only word that comes to mind to describe it. Yes, it’s below 50%. And when you look at the statistics for young people, it’s even worse. It’s a complete mess. There are lots of proposals for what to do about that. One of the proposals that folks are talking about is making the minimum wage lower in Puerto Rico. Would that help with employment? But it’s a mess at this point.
Knowledge at Wharton: So timetable-wise, what are we looking at here in terms, first, of how long we have to potentially find a short-term solution? And second, realistically, for a long-term solution? We need to set something up so that this doesn’t happen again.
Skeel: I think that’s right. There’s a short-term time frame, and a longer-term time frame. The short-term time frame is that big July payment that comes due. I think right now, people are looking at that as the guillotine, that something needs to be done by then. But that’s just putting whatever the help is in place. If you put a control board and a bankruptcy option in place, you’ve still got to use it. You still have to fix the government. You still have to put together a five-year plan. I do think it’s a five-year process, basically, from the moment that Puerto Rico has the levers it needs to be able to pull.
Knowledge at Wharton: But even if they somehow get those near-term debt payments made somehow — if Washington throws them a big check to cover the $400 million payment they missed last week, and the $800 million due in July — they still have something like $69 billion worth of debt that they’ve got to take care of at this point.
Skeel: Absolutely. And they’ve got a shrinking economy. The island’s economy is expected to shrink a little over 1% this fiscal year. It’s expected to shrink 2% next year. The lines don’t look good. The debt’s going up, and the income’s going down.
Knowledge at Wharton: Is it as simple as really throwing some attractive options to corporations to induce them to make investments in Puerto Rico again?
“If you put a control board and a bankruptcy option in place, you’ve still got to use it. You still have to fix the government. You still have to put together a five-year plan.”
Skeel: That’s a great question. That is not an option that seems to be on the table. When people are talking about how to get the Puerto Rico economy growing again — some people do say, “Give us back our tax break.” But that doesn’t tend to be one of the options. People tend to talk more about, should the minimum wage be lowered for Puerto Rico? Puerto Rico does not do as well as the states in terms of Medicaid reimbursement from the government, so there’s talk about fixing that. There’s talk about a variety of other things.
But at least at this point, there doesn’t seem to be serious pressure to reinstate that tax break, although I think that would make a big difference.
Knowledge at Wharton: You just alluded to the fact that Medicaid and the economics of health care continues to be a growing problem for the island. Are they similar to what we see here in the United States right now?
Skeel: They clearly are a big, big problem. And if anything, I think it’s magnified in Puerto Rico. It’s small, and they also have, at this particular moment, some extraordinary health threats. The Zika virus is there now. And it’s unclear what’s going to happen with that. And so there is an order of magnitude more uncertainty, I think, in Puerto Rico, than there is in the U.S. And there’s a huge uncertainty still about health care-related issues in the states.
… When we talk about helping out the Puerto Rico economy or the way forward for the Puerto Rico economy, one of the things people talk about is revitalizing the tourism industry. The Zika virus complicates that.