After months of fielding criticism for standing idly by while Puerto Rico sank under a $72 billion heap of debt, the Obama administration is getting creative. On October 21, the US Treasury, the Department of Health and Human Services (HHS), and the National Economic Council (NEC) released a joint proposal for federal bankruptcy legislation to restructure all of Puerto Rico's debts. Debt relief would come in exchange for fairly intrusive federal oversight, combined with Medicaid reform and federal tax relief to help mend the island's fraying social safety net.
The scheme was floated ahead of congressional hearings on October 22, just as Puerto Rico announced it was suspending talks with bondholders while still holding out the hope of a comprehensive negotiated debt restructuring before a December 1 payment deadline. Any such deal would now be done in the shadow of the legislative prospects (if any) for the administration's proposal. Meanwhile, Puerto Rico's cash shortfall is projected to be $14 billion over the next five years, even assuming successful implementation of drastic economic reforms (in other words, austerity). For the remainder of 2015, Puerto Rico is getting by on "emergency measures," moving scraps of cash from one domestic pocket to another.
The bankruptcy law would be the most novel and far-reaching part of the federal scheme. The "roadmap" just released is thin on details, but the key features of the debt restructuring framework are fairly straightforward.
- Long-pending legislation to let Puerto Rico's agencies and municipalities file for Chapter 9 bankruptcy protection is deemed necessary but not sufficient. It would cover about a third of the commonwealth's debt, some of which is secured using statutory mechanisms that would be complicated to unwind. This debt cannot be erased completely. Even if it bears the full brunt of the restructuring, quite apart from being unfair, it would not deliver enough relief.
- The administration's proposal envisions a comprehensive, judicially supervised restructuring process for Puerto Rico and all of its various borrowing limbs, including the Government Development Bank, public utilities, infrastructure, and municipal authorities—18 entities in all. It would stop short of consolidating all the entities into one, but might institutionalize (de jure or de facto) a coordination process and a pecking order among their various liabilities.
- The relative order of repayment priority among the various obligations of different Puerto Rico issuers is a big bone of contention for the 20 different creditor committees formed to negotiate with the government.
- The insanely convoluted debt structure includes bonds whose priority repayment is guaranteed by the Puerto Rican constitution, bonds governed by New York law, bonds secured by sales tax revenue routed to the creditors by statute, bonds secured by other revenue pledges that could be more easily diverted, and bonds payable if the legislature appropriates the money. There are also pensions and other government obligations to its citizens, which have their own constituencies and protections. It seems like most creditors believe they are senior to someone, like the above-average children of Lake Wobegon.
- For much of the debt, particularly the unsecured part, federal bankruptcy legislation might preempt Puerto Rican law; however, recasting the priority structure entirely might upend investor expectations and send an awkward message to the municipal bond markets. Therefore it is more likely that any federal intervention would try to honor local law priorities more or less the way corporate bankruptcy law honors contractual priorities.
- The Treasury-HHS-NEC release suggests other attributes, including a shield from enforcement (automatic stay), a creditor classification mechanism, and classified voting (probably on an entity-by-entity basis). Presumably the scheme would also include some protection for minority creditors facing cramdown, and criteria for plan confirmation that would ensure a modicum of fairness across entities and across classes.
- The administration concedes that it has no authority to establish such a process without legislation tapping into the federal government's bankruptcy powers under the US Constitution; however, it is clearly at pains to delimit the reach of the law. As written, the proposal would only apply to territories (of which Puerto Rico is the biggest by far), not states—which remain more robustly sovereign.
Details of the federal oversight mechanism are thinner yet. It would include both policy reform and better fiscal accounting, modeled on federal control boards of yore, except that the release avoids the word "control" and treads gingerly on the whole oversight business in an effort to balance commonwealth and federal political concerns.
In all, this is an interesting and important development even if the proposal goes nowhere on Capitol Hill—as do most things these days. The administration put its chips on a robust statutory framework for quasi-sovereign debt restructuring. Presumably it reached for a legislative fix in recognition of its own limited powers and the fact that Puerto Rico, unlike most fully independent sovereigns, cannot simply run from its creditors forever: At least some of its debt contracts give creditors nontrivial enforcement powers. On the other hand, the overwhelming emphasis on debt relief signals that there is no federal bailout godmother waiting in the wings at the Treasury or the Fed.
Today's Congressional hearings might flesh out the details, though I suspect most would be left for negotiations with the Congress and the creditors—which may look rather different in the wake of this move. If I were doing the questioning, I would want to know how prescriptive the administration is willing to be on the treatment of different creditor groups, and how the oversight-not-control mechanism would deliver for all the constituents on and off the island.
Finally, I would not get too excited about the precedent value of this proposal for state or international sovereign bankruptcy. We are still in the land of apples and oranges, with lots of fruit in between.
A version of this essay was posted on Credit Slips.