Puerto Rico Gov. Alejandro García Padilla's developing plan to restructure the public sector's $72 billion of debt, which would dwarf any other municipal debt restructuring, is part of a larger plan to overhaul the commonwealth's governmental practices.
In comments to the New York Times this weekend and a statement in a Monday press release, Puerto Rico Gov. Alejandro García Padilla suggested that a comprehensive restructuring of the debt was necessary.
The governor told the Times that the debt is "not payable." Creditors "must share the sacrifices." If they do not, "What will happen is that our economy will get into a worse situation and we'll have less money to pay them. They will be shooting themselves in the foot."
On Monday morning the governor praised a
The report, also released Monday, calls for fiscal adjustment, structural reforms, and debt restructuring. As for the latter, the authors say that even after Puerto Rico took major revenue and expenditure measures, there would be large financial gaps. These would peak at about $2.5 billion in fiscal 2016 and generally decline to about $0 in fiscal 2024.
By comparison the total commonwealth government debt service in fiscal 2016 is slated for about $3.6 billion.
"Debt relief could be obtained through a voluntary exchange of old bonds for new ones with a later/lower debt service profile," the authors wrote. "Negotiations with creditors will doubtlessly be challenging." They make clear the general obligation as well as other commonwealth government debt should be restructured.
The authors also call for negotiations on the public corporations' debt and for the federal government to make the corporations eligible for Chapter 9 bankruptcy.
The authors respond to the objection that the restructuring of general obligation debt would face "unprecedented legal challenges," by stating that the restructuring is absolutely necessary. Even with their suggested increases in taxes and cuts, the government faces huge gaps.
They also say that while the tax to gross national product ratio may seem low by United States standards, Puerto Rico's tax rates are high. Additionally, one would have to consider the impact of further increases of the taxes on economic growth, to consider how realistic the suggestion would be.
In response to those who might say that Puerto Rico's debt to GNP ratio is lower than that of many strong economies, including Germany and the United States, the authors note that island currently has near zero nominal GNP growth. This is not the case in many of the other economies with more debt.
In addition to calling for a debt restructuring, the authors called for major structural reforms, fiscal reform, and measures to boost government credibility.
In terms of structural reforms, one of the changes they call for in Puerto Rico is either the elimination of the federal minimum wage or its reduction to one third of its current level. They call for substantial changes to the local labor laws to make earning overtime pay more difficult, halving the number of vacation days, ending mandatory end-of-year bonuses, substantially extending probationary period for new employees, and relaxing labor laws for youths.
They also call for the federal government to end the Jones Act, which adds to the cost of shipping goods to and from Puerto Rico.
The author's say their reports most "startling finding" is that the government's true fiscal deficit is larger than understood. On the expenditures side they call for various cuts that would lead to $2 billion in savings per year by fiscal 2020 and $2.5 billion by fiscal year 2025. For revenues, they suggest tax measures yielding around $3 billion by fiscal 2020 and $4 billion by fiscal 2025.
In terms of increased institutional credibility, they call for legislative approval of multi-year budget plans, legislative rules on deficits, a fiscal oversight board, and more reliable projections of revenues.
The governor was scheduled to make a speech on Puerto Rico's situation at 5 p.m. eastern time Monday, after press time, which was to be broadcast on the Web at Fortaleza.pr.gov/envivo.
The governor's interest in negotiating a restructuring of the commonwealth's debt was made public in April 30. In his annual state of the commonwealth speech, while he described the idea of not paying the debt as "ridiculous" or "garbage," he also called for talks with the government's creditors similar to those already underway with those for the Puerto Rico Electric Power Authority.
PREPA chief restructuring officer Lisa Donahue has indicated that the authority is talking with the creditors about possibly restructuring the authority's debt.
Also, according to a letter from Puerto Rico's nonvoting representative in the United States House of Representatives Pedro Pierluisi and press accounts, in the last few weeks the governor has made inquiries in the United States Congress about it passing laws allowing a possible general Puerto Rico bankruptcy. According to these reports, when he was rebuffed, he withdrew the proposal.
Nevertheless, on Monday two analysts said Washington's help may be key for Puerto Rico. "If Congress fails to provide an organized structure to resolve the island's financial problems, I fear the situation would deteriorate into protracted and complex litigation," said Wells Fargo Securities managing director Natalie Cohen. "At least Chapter 9 provides a stay on creditor actions, which offers breathing room to put forth a plan."
Jim Spiotto, managing director of Chapman Strategic Advisors, said Puerto Rico needs to take one or both of two paths. They could to create a completely safe lock box pass-through for revenue or taxes for bond payments. This could possibly be controlled by the federal government. With this they could borrow again.
A second approach would be to refinances their debt with the federal government. With this they could gain a 25% cut in net present value of their debt, Spiotto said.
While a spokesman for Pres. Barack Obama said the federal government wasn't considering a bailout of Puerto Rico on Monday, Cumberland Advisors managing director John Mousseau said it would be interesting if García Padilla would appeal for federal help in his speech.
Spiotto said that if Puerto Rico simply tried to repudiate its debt, it would be going down the wrong path. Spiotto, a leading expert on U.S. municipal bankruptcy, said that in 1840 seven states and one territory hit hard economic times and declared their debts invalid. Florida and Mississippi stayed the course on default but neither could borrow for more than 10 years.
When the other states and the territory soon found they could only borrow at 32% interest rates, they quickly renounced their earlier repudiation, Spiotto said.
"It isn't a solution for Puerto Rico to run afoul of the traditions of the debt market because it will only increase the costs for Puerto Rico," Spiotto said.
If Puerto Rico attempts to default on much or all of its debt, there will be a "long and messy" fight in local courts, NewOak Managing Director Triet Nguyen said Monday. Only suits on the series 2014 GO bonds would take place in a state-side court, he said.
On Friday Nguyen wrote in his blog, "Yet is a 'holistic' debt restructuring even possible for PR, given the wide array of creditor groups with starkly different motivations? The mutual funds are hell-bent on clipping the tax-exempt coupon for as long as possible and may be willing to take some capital losses in the process. The bond insurers feel they're adequately capitalized as long as they only have to pay principal and interest when due and no actual haircut to principal is required. The hedge funds are focused primarily on capital appreciation, and the haircut they may accept will depend primarily on what their cost basis is."
Nguyen added that the hedge funds are split in their positions about what should be done between those that hold GO debt and those that hold public corporation debt.
Krueger, one of the authors of the report, is a neo-liberal economist known for having been tough with creditor countries in her past positions at the IMF and the World Bank, said Advantage Business Consulting president Vicente Feliciano. Because of this you can believe her when she says that even with a big effort Puerto Rico would not be able to pay all of its debts.
Moody's chief Puerto Rico analyst Ted Hampton wrote that the governor’s “declaration that the commonwealth's debt is 'not payable' reflects our views." Moody's ratings are consistent with a high likelihood of default, he said.
On Monday, Fitch Ratings dropped its Puerto Rico GO rating to CC from B. The rating remains on credit watch negative. Its ratings of other sorts of Puerto Rico debt are also at CC. The downgrade was based on the governor's endorsement of "Puerto Rico A Way Forward"'s support of debt restructuring, Fitch said.
Prices of Puerto Rico's general obligation bonds declined in trading Monday after the report. Puerto Rico commonwealth Series 2014A general obligation bond 8s of 2035 were trading as low as 68.50 cents on the dollar on Monday, according to the Municipal Securities Rulemaking Board's EMMA website. This was a sharp decline from their prices on Friday, when the GOs traded as low as 76.75, according to EMMA.
