When Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) last summer, it created a roadmap to address the island’s $70 billion debt crisis and revitalize its economy. The impact of the law, which was intensely debated among policymakers inside the Beltway and the financial community on Wall Street, now bears watching for millions of Americans living in debt-ridden municipalities and states across the country.
The reality is that aging populations, mounting healthcare costs and significant pension obligations are placing many state and local officials in unenviable positions. Similar to the dichotomy that plagued Puerto Rican leaders for a decade, the need to cut expenses and limit indebtedness runs counter to mainland policymakers’ desires to keep taxes low and maintain popular entitlements.
In the case of Puerto Rico, PROMESA provides a blueprint to navigate an orderly restructuring. The bill put into place a temporary freeze on creditor lawsuits and required Governor Ricardo Roselló to submit a fiscal plan to the bi-partisan federal oversight board that was formed in the fall. It also established a process to convene voluntary negotiations amongst creditors before proceeding to a court-supervised restructuring phase provided for under Title III of the law.
To be clear, PROMESA is imperfect and may not have included enough runway for the Oversight Board to implement every growth reform contemplated by Congress. But it gives Puerto Rico much-needed tools that were battle tested in New York City, Philadelphia and Washington, D.C. These municipal restructurings saw secured creditors’ rights respected in a way that enabled the cities to re-access the capital markets and eventually stimulate their once-crippled economies.
Puerto Rico’s largest debt issuance, known by the Spanish acronym COFINA, is a secured bond with a constitutionally-protected lien on a dedicated portion of the island’s sales tax. COFINA was the original “rescue bond” created through a bi-partisan act of the Puerto Rico Legislative Assembly in 2006. The island used this tax-backed secured borrowing solution to avert its last fiscal crisis—and it continues to work today even as unsecured debts have entered payment default and related claims have mounted.
Over the next month, Puerto Rico will traverse a critical stretch on its road to recovery as willing creditor groups conclude mediation and voluntary negotiations. Although I hope the discussions ultimately spur constructive outcomes, the Rosello Administration and Oversight Board need to act decisively if talks do not spur immediate deals.
A raft of aggressive creditor lawsuits is set to occur when PROMESA’s litigation freeze ends on May 1. Absent an orderly Title III restructuring at that time, the Governor and Oversight Board will be rolling the dice on disruptions that may compound the island’s economic and social challenges.
Title III of PROMESA, which is modeled after Chapter 9 of the Bankruptcy Code and nearly a century of legal precedent, provides a framework for protecting Puerto Rico’s citizens while also respecting the legitimate rights and priorities of creditors. For example, the recent Chapter 9 restructuring in Detroit sought reasonable accommodations for vulnerable pensioners and respected secured creditors’ rights.
Preserving the sanctity of secured debt is established and sound public policy. It remains the best vehicle for efficient underwriting and low-cost municipal borrowing. Most importantly, securitizations are particularly beneficial for stressed municipalities that need to rely on statutory liens and debt issuances secured by collateral to provide bondholders confidence of repayment.
While many obstacles are ahead on Puerto Rico’s path to financial health, the success of PROMESA and the prioritization of the $17 billion COFINA structure bears close watching for citizens, government officials and investors across the United States. The next chapter for Puerto Rico is likely to establish precedents and processes that guide America’s next wave of municipal restructurings.