The core of any deal to address Puerto Rico’s imminent debt default long has been clear: strong fiscal oversight, paired with powerful tools to facilitate a necessary debt restructuring. But oversight should not overreach, and the new restructuring tools should respect the differences created by existing contracts. The legislation (PROMESA) that emerged from the House achieves the needed balance; it needs to pass the Senate quickly.
Fiscal oversight is necessary. Puerto Rico has a history of fiscal gymnastics, often passing budgets that balance only on paper. Contrary to oft made claims of out of control spending, ongoing deficits have stemmed at least as much from revenue shortfalls. Between 2004 and 2014, average annual revenues fell a billion and half dollars – around 15% of the annual budget — short of projections.
Puerto Rico cannot continue to fill fiscal gaps by skipping contributions to already under-funded pensions, delaying payment of vendors and cannibalizing future tax collections with one-off tax agreements. Nor can Puerto Rico continue to circumvent its constitutional limit on debt service by developing ever more creative ways to shift payments off budget.
Strong fiscal oversight needs to be combined with respect for the Commonwealth’s existing institutions. PROMESA leaves day-to-day administration in the hands of Puerto Rico’s elected government. The oversight board will step in only if the governor and legislature fail to agree on a budget consistent with long-run fiscal targets after multiple attempts. The board can propose measures that it believes would strengthen Puerto Rico’s broader economy. But it cannot unilaterally impose these measures on Puerto Rico’s legislature. Only the governor – not the oversight board – can decide whether or not to use PROMESA’s provision for a sub-minimum wage for workers under age 25.
Austerity alone would be self-defeating. Greece’s experience makes that clear. With Puerto Rico now in year ten of a recession, strong restructuring tools – and the political will to use them – are every bit as necessary as fiscal oversight. A return to sustainability requires protection from disruptive litigation, and a workable process for reaching agreement with creditors on new, sustainable payment terms.
PROMESA delivers both. It provides a full standstill on litigation, effectively prioritizing the provision of essential public services over near-term debt service. If direct negotiations with creditors fail to produce a quick agreement even with the help of new provisions that allow groups of holders of Puerto Rico’s bonds to vote collectively on restructuring terms, the oversight board can file for an extended period of protection under the provisions of Title III of PROMESA, a special process for restructuring the debts of U.S. territories that draws significantly from municipal bankruptcy law. Here the courts will play a bigger role, as, at the conclusion of Title III, a judge can potentially confirm a plan of adjustment over the objections of a class of creditors. Holdout strategies will not work.
The restructuring process needs to protect existing relative priorities: senior bonds should be confident that they will do better than subordinate bonds; and bonds that benefit from Puerto Rico’s constitutional priority should expect to do better than bonds subject to its “claw back” provision. But respect for these provisions in existing contracts also should not harden into absolute priority enforced by the federal courts. There simply isn’t enough cash available to pay all the bonds that claim to be at the top of the debt stack. Everyone needs an incentive to compromise.
The restructuring process set out in Title III appears to get this difficult balance right. A restructuring plan can only be confirmed if the court judges that its terms reflect existing priority norms and if its implementation is economically and financially feasible. The oversight board has a critical role here, as it has to certify that the debt restructuring terms are sustainable. If the oversight board errs on the side of fiscal austerity, it will fail. And, yes, this means recognizing that there are economic, if not moral, limits to the size of cuts that realistically can be absorbed by poorer on-island public pensioners. Puerto Ricans are Americans who can choose where they live, work, invest and retire. They will not stay on island if tax revenues all go to pay legacy debts, with nothing left for basic public services or investments in future growth.
PROMESA’s new framework for budgeting and debt negotiation does not on its own assure success. A bipartisan oversight board will only work if its members find common ground and exercise their authority in way that ultimately strengthens Puerto Rico’s own institutions. But we can be confident that PROMESA would increase the odds that Puerto Rico can find a path back to growth and sound finances. Without its new tools, we know Puerto Rico faces a future of default, litigation, degraded public services, more outmigration and an even deeper recession.
Brad Setser is a senior fellow with the Council on Foreign Relations. From 2011 to 2015, he served as the deputy assistant secretary for international economic analysis in the U.S. Treasury where he worked on Puerto Rico’s debt crisis.