Puerto Rico on its way to becoming the next Argentina — an economic disaster
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The Trump administration and Congress should act swiftly to prevent a federal oversight board from turning Puerto Rico into the next Argentina. 

Thanks to its former Presidents Néstor and Cristina Kirchner, Argentina is widely regarded as an excellent case study in how not to restructure sovereign debt. Rather than negotiate in good faith with its creditors, Argentina attempted to dictate terms. Rather than respect U.S. law, Argentina flouted it. Argentina’s high-handed tactics left the country bereft of international investment and brought disaster to its economy. 

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Ironically, the bondholders (including my firm) that were not cowed ultimately recovered much more than if Argentina had reached a fair settlement when we had sought it much earlier. In contrast, Ukraine, Greece and Belize swiftly restructured their debts by negotiating constructively with their creditors.

 

Sadly, the federal oversight board for Puerto Rico has decided to turn that commonwealth into the next Argentina. The oversight board, composed of seven political appointees, was established by The Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), a statute rushed through Congress last year.

Through extensive observation of the oversight board in my firm’s capacity as a holder of Puerto Rico’s general obligation (GO) bonds, I reached the conclusion two months ago that the board was determined to sabotage out-of-court restructuring negotiations and force Puerto Rico into bankruptcy. Unfortunately, I was right. 

On May 2, my firm and several other leading GO bondholders were on the verge of cinching an out-of-court deal with Puerto Rico’s government, when we were told that the oversight board had “pulled the plug” on this effort. The next morning, the oversight board filed Puerto Rico for bankruptcy.

This filing gave the unelected board the exclusive power to decide for Puerto Rico how its bankruptcy will be managed, thereby rendering the commonwealth’s governor and legislators mere bystanders in the exorbitant saga that is about to unfold. The board’s own lawyer will run the bankruptcy case for Puerto Rico — at Puerto Rico’s expense. Despite Puerto Rico’s aspirations to become a state, the oversight board is treating Puerto Rico like a colony.

The parallels with Argentina are striking. For starters, the oversight board has taken an extreme and unyielding position on Puerto Rico’s ability to service its debt. The board insists that, over the next 10 years, Puerto Rico can only afford to spend about 7 percent of its revenues servicing debt. This percentage defies all commercial norms for sustainable debt service. 

For example, Connecticut and Utah spend 12 percent and 15 percent of revenues, respectively, servicing their debts; and Puerto Rico’s constitution limits its annual debt service to 15 percent of revenues. Moreover, the joint World Bank/IMF guidelines regard 18-22 percent of revenues as sustainable annual debt service for the poorest countries in the world (those nations far less developed than Puerto Rico). 

The oversight board’s radical position seems perfectly designed to prevent consensual deals, since bondholders cannot be expected to accommodate an indefensibly low assessment of Puerto Rico’s debt service capacity.

Second, as noted above, the oversight board has repeatedly acted to delay and impede negotiations and even “pull the plug” on the deal the commonwealth nearly reached with the GO bondholders. Like the Kirchners in Argentina, the board members seem more interested in imposing their will than in allowing Puerto Rico to reach a swift and fair deal with creditors. We fear this hubris will impose a terrible price on Puerto Rico’s economy and people, as it did in Argentina.

Third, the oversight board is flouting the law, including the explicit requirement in PROMESA that the fiscal plan “respect” the priorities and liens granted bondholders in Puerto Rico’s constitution. While the constitution says the GO bonds come ahead of all other commonwealth expenditures, the board has certified a fiscal plan that demands the opposite. The oversight board offers no defense for its position but regularly points out instead that its decisions about the fiscal plan are exempt from judicial review.

The oversight board was supposed to impose financial discipline on a notoriously mismanaged government, which was in turn supposed to help the commonwealth efficiently reach consensual deals with its creditors and regain access to the capital markets. Emboldened by its oft-declared claim that it can act with impunity, the oversight board has perverted these goals. 

If the board has its way, debt service will be cut by about 80 percent, but other expenditures will modestly increase over the coming decade — this at a time when Puerto Rico's nominal GNP and governmental revenues are both at all-time highs.

Now that the oversight board has complete control over Puerto Rico’s handling of its bankruptcy, we fear fresh proof of the adage that absolute power corrupts absolutely. That will be a headache for my firm, but we will prevail because the law is on our side. Unfortunately, the people of Puerto Rico will end up bearing the burdens of this federally-created autocracy.

The oversight board has gone rogue and urgently needs adult supervision before lasting damage is done to Puerto Rico. Already, the board has flouted PROMESA, impeded consensual negotiations and pushed the commonwealth into a needless bankruptcy. Congress and the administration should require the oversight board to comply with PROMESA, or they should replace the board members with people who will.

 

Mark D. Brodsky is the CEO of Aurelius Capital Management, LP, a New York-based hedge fund.


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