House Hearing Probes Impact of Puerto Rico Debt Crisis on Bond Market
SAN JUAN – Participants at a U.S. House subcommittee hearing on the Puerto Rico debt crisis—among them former International Monetary Fund managing director Anne Krueger and Mark Zandi, chief economist at Moody’s Analytics—agreed Thursday that the U.S. territory needs to be included under Chapter 9 of the U.S. Bankruptcy Code, and called for an independent federal oversight board.
The hearing by the Subcommittee on Oversight and Investigation was the second held Thursday, and one of several that House Republicans have held in recent weeks to address Puerto Rico’s fiscal crisis, with its more than $70 billion in public debt spread across 18 different issuers.
Talks to extend bankruptcy protection to the territory have been challenged by members of Congress, who have cataloged such moves as a “bailout” that would be unfair to mainland constituents who have invested in Puerto Rico bonds. The island is the third largest issuer in the U.S.’s $3.7 trillion municipal bond market, with about 20% of U.S. bond funds holding Puerto Rican debt.
Much of the discussion at the hearing centered on House Bill 4199, authored by subcommittee Chairman Sean Duffy (R-WI), which seeks to extend Chapter 9 protection to municipal and public corporation debt, or about 30% of the island’s total debt. “HR 4199 is a very positive step,” Zandi said. “The combination of Chapter 9 access to municipalities and public corporations and the implementation of a control board strike a nice balance but is not enough.”
The Moody’s economist instead recommended shifting the focus from Chapter 9 to a broader restructuring framework. He also insisted on several measures that would enable economic growth on the island, among them ensuring that current Medicaid federal funding under the Affordable Care Act is not scaled back beginning in 2018 as currently legislated, and the implementation of an earned income tax credit (EITC).
“It would provide a meaningful boost to the Puerto Rican economy,” Zandi said. “The EITC is an effective way to provide income support to low-income workers, and is available only to those that work, which encourages labor-force participation.” He acknowledged, though, that implementing both measures would cost U.S. taxpayers about $20 to $30 billion over the course of a decade.
Krueger, who co-authored a sobering report published last summer on Puerto Rico’s fiscal and economic crisis, stressed the need to establish a legal framework that would enable a comprehensive restructuring of Puerto Rico’s debt.
“With no protection in U.S. bankruptcy law, any group of creditors can take the case for their priority to courts,” said Krueger, who is a senior research professor of international economics at John Hopkins University. “The period in which court proceedings were continuing would be a further period of declining real incomes and continued outmigration…. Puerto Rico’s economic recovery would start from an even worse position than the one it is now in.”
William M. Isaac, a senior managing director at FTI Consulting, said he was concerned by proposals coming from the Treasury Department that propose a so-called “Super Chapter 9 bankruptcy” or a “Super Control Board” that would provide for the restructuring of all of Puerto Rico’s debt, even its general obligation (GO) debt, which is protected by the Puerto Rico Constitution. Currently, no state has the ability to restructure its own general obligation or debt.
“Granting this power to Puerto Rico, or to a ‘Super Control Board’ created by Congress, would be unprecedented and would have far-reaching implications, including raising the costs of borrowing for the fifty states,” Isaac added. “Don’t let the stink spread; if we change bankruptcy rules, it takes us down a road we don’t want to go on.”
Juan Carlos Batlle, who presided the Government Development Bank (GDB) under the administration of former Puerto Rico Gov. Luis Fortuño, agreed on having Chapter 9 protection and a federal oversight board. He also coincided with Isaac on the potential danger of extending bankruptcy protection to GO bonds. “The bond market doesn’t like surprises,” said Batlle, who is a senior managing director at CPG Island Servicing. “Introducing an unfamiliar mechanism would upset a very stable market and set a dangerous precedent.”During the hearing’s question and answer period, Batlle’s interactions with members of Congress proved somewhat contentious, with Puerto Rico-born Rep. Lydia Velázquez (D-NY) being particularly pointed in her remarks. “Mr. Battle, you were in charge of the GDB, and during that time, the debt doubled,” she said at one point.
Various other members of Congress, among them Rep. Mick Mulvaney (R-SC), challenged the hearing’s witnesses. “The Treasury would prioritize pensioners [in the disbursement of funds] before bondholders; that is not fair,” Mulvaney said. “Also, some debt revolves around the island’s electric utility, which has not raised its rates on people since 1989. Overall, this looks to me like a bailout.”
To this, Moody’s Zandi responded that “the pain would be more distributed around the globe for bondholders; meanwhile, pensioners are sitting right there on the island.” Krueger also reminded Mulvaney that electricity rates are nonetheless among the highest in the U.S., costing about 27 cents per kilowatt-hour.
Rep. Bruce Poliquin, a Republican congressman from Maine, took the island’s political class to task for the crisis. “There’s been reckless behavior in this territory,” he said. “There had to be incentives, political or otherwise, to increase the island’s debt to unsustainable levels. Right now, senior citizens in my constituency own Puerto Rico debt, and stand to lose their savings. Any solution that Congress will come up with has got to include a structural fix, so this situation doesn’t happen again.”