Puerto Rico's Monday meeting with its bondholders puts the commonwealth and its creditors on an unpredictable path of negotiation and litigation, if history is any guide.
Puerto Rico officials and two authors of a report recommending restructuring the territory's $72 billion debt will make a presentation and take questions from bondholders. The event will take place at one of Citibank's mid-Manhattan offices for those who have already reserved a spot. The web site of the Government Development Bank for Puerto Rico, www.gdb-pur.com, will provide link to a live web broadcast of the event.
With Gov. Alejandro García Padilla saying the commonwealth's debt needs to be restructured, Monday's meeting is likely to be the start of a struggle with at least some of the bondholders. History suggests it could take could take from months to decades to resolve the issues.
Unlike most United States municipal defaults since World War II, Puerto Rico starts the process without a bankruptcy process to use -- or wave as a threat to bondholders while it negotiates. For historical parallels, experts cite several notable municipal defaults before the Chapter 9 municipal bankruptcy became available in 1937, as well as some defaults and near defaults since 1937, where the debtors have not used Chapter 9.
In the late 1830s and early 1840s seven states and the territory of Florida borrowed money for either transportation improvements or for in-state banking services, said Chapman Strategic Advisors managing director James Spiotto, in an essay on MuniNetGuide. An economic slowdown around this time and a credit crunch led debtors to repudiate their obligations, he wrote in "The History of Payments of State and Local Government Debt in the United States."
Facing 32% interest rates to complete their projects, by 1848 six states chose to renounce their repudiation. Mississippi and Florida couldn't borrow on the public market for nearly two decades, Spiotto wrote.
In the midst of the Great Depression, Arkansas defaulted in 1933. However, as part of Franklin Roosevelt's response to the economic crisis, the federal government introduced financial aid for state governments. With this help, Arkansas was able to refinance all of its debt from 1933 to 1935 and the existing bondholders were paid off, Spiotto said.
In the 1970s the Washington Public Power Supply System invested heavily in building five nuclear power plants. Organized by utilities and irrigation districts in Washington, Oregon, and Idaho, the system was ineligible for Chapter 9.
Due to poor management on WPPSS part, the inflation of the period, changing regulations, and other factors the system ultimately believed completing the plants would cost three-to-four times more than originally estimated, and completed only one plant.
Having abandoned construction of plants 4 and 5 after construction had started, in 1983 WPPSS defaulted on $2.25 billion in bonds that primarily supported this construction.
The outcome of this was far longer and harder than it had been for the depression era Arkansas bondholders. Litigation on the default would continue for 13 years. Bonds were ultimately paid at from 40 cents to just 10 cents per dollar par value.
History suggests that Puerto Rico could benefit from some form of federal oversight, said Wells Fargo Securities managing director Natalie Cohen. Michigan has an emergency management system for its localities and Pennsylvania has a similar Act 47, she said. In the 1970s New York State's Emergency Financial Control Board as well as the Municipal Assistance Corp. helped New York City sidestep bankruptcy.
In the mid-1990s Washington, D.C.'s government was experiencing financial distress, and in 1995 the U.S. Congress appointed a federal financial control board to oversee its decisions.
In the case of Puerto Rico a federal "oversight structure would provide central control over the planning process and hopefully implementation support for necessary institutional and operating changes," she said.
Cohen said that a problem with Chapter 9 is that it is solely under the control of the debtor. "The solutions a municipal debtor is likely to choose would be adverse to bondholders without necessarily addressing organizational practices that may have contributed to the distress in the first place.
"Vallejo [Calif.], for example, continues to have a city with high crime and fiscal distress - despite debt impairment through their Chapter 9 - and they never attempted to address the costs of their pension and other retiree benefits; Stockton [Calif.] and San Bernardino [Calif.] too have stayed away from a more comprehensive overhaul of their benefit structure."
By contrast, Puerto Rico Gov. Alejandro García Padilla has indicated that he may adopt certain measures to address labor and welfare conditions on the island, Cohen said. The governor's introduction of some of these changes would improve productivity to make the island a "more investible place," Cohen said.
