Puerto Rico government-owned corporations should be allowed to file for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. Circumstances have changed and a different approach to Puerto Rico debt is warranted.
During the American Revolution, when the British were faced with a significant change in circumstance, they opted to change their policy. After their defeat at the battle of Yorktown, when the Continental Army was aided by the French, the British still held the key ports of New York and Charleston, still had the most powerful navy in the world and still had support from loyalists on the ground. However, the British were unwilling to continue fighting because of a hard-headed cost-benefit analysis. Circumstances had changed significantly. After Yorktown and the French intervention, it was untenable to pursue the same course and political support in Great Britain for continuing the war evaporated.
The cost-benefit analysis for Puerto Rico paying in full the debt of its government-owned corporations (Puerto Rico Electric Power Authority, Puerto Rico Aqueducts & Sewer Authority, Puerto Rico Highways and Transportation Authority and Puerto Rico Ports Authority) is becoming untenable. The main benefit of paying debt is that you get access to capital markets at reasonable rates. While Puerto Rico general obligation bonds have market access, these government corporations have no access to capital markets and the outlook for change in the foreseeable future is nil. In contrast, Detroit defaulted in 2012 and is getting access to markets at close to 4%. Thus, the benefits of paying seem elusive.
The costs are too evident. The limited credit available to the central government and the GO bonds is being used to prop up these corporations. Moreover, financing infrastructure and utilities at rates close to 10% hampers the Puerto Rico economy and growth prospects. In this line of argument, paying the government corporation debt weakens the capacity to service GO debt.
Restructuring government corporations would not be painless. It could entail transferring hundreds of employees from these corporations to the central government with a lower compensation. However, some estimates place the debt of the Highways Authority at five times the value of the assets. PREPA is partly responsible for the fact that a hotel room in Puerto Rico is more expensive than a hotel room in Florida.
The Puerto Rico economy has continued to contract due to tax increases and spending cuts, and despite strong economic growth in the United States. These conditions exacerbated the trend in emigration. In fiscal year 2014, natural population growth was 0.2% of the total population, while emigration was minus 1.5%, for a net of minus 1.3%. The government needs to make a case to residents that staying on the Island and getting taxed to pay government debt is an attractive proposition.
Some sectors of the Puerto Rico economy are showing promise. These include tourism, aeronautics and the export of services. However, manufacturing seems weak. During 2014, manufacturing contracted in seven different months. Contrast this with Ireland, which has a similar manufacturing profile to that of Puerto Rico. Ireland had positive growth in each of those 12 months. If the present level of taxes and electricity rates is sapping the strength of the manufacturing sector, the current course of action must be reassessed.
Foremost in the minds of the British in the 18th century was the possibility of contagion: If they restructured their relationship with the 13 colonies (i.e. independence), would it lead to a slippery road going from Canada all the way to India? The strongest argument for continuing to pay the government corporation debt is contagion of GOs and other Puerto Rico debt. The concern is overblown.
In June 2014, an official statement from the Puerto Rico government published in the Government Development Bank website noted that "the public debt of the Commonwealth should not be seen as a sum of debts to a single debtor, but rather as individual loans supported by various sources of revenues and income, with certain priorities established by law or contract."
Most important, the financial markets treat the debt of government corporations differently than GOs. While discounts on GOs can reach 15%, discounts on government corporation debt can reach 50%. Their credit ratings are different. The difference in market access was previously mentioned. During the discussion on allowing Puerto Rico government-owned corporations to file for Chapter 9, investors holding GOs have been in favor.
The collapse in the price of oil provides Puerto Rico with a new opportunity. Part of this windfall could be channeled to pay bondholders. While the fall in oil prices reduces the cost of pursuing the present debt-payment policy, it does not preclude the need for a cost-benefit analysis.
In the end, the British "restructured" their relationship with its former 13 colonies. Going forward, the willingness to pay must be sustained by a hard-headed cost-benefit analysis. The people of Puerto Rico must buy into this analysis for the present course to be continued. Unless the economy starts to grow soon, this will be a tough sell.
Vicente Feliciano is President of Advantage Business Consulting.
