The Steep Road of Recovery

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December 2, 2015. Share on Twitter

The Steep Road to Recovery. The route out of municipal bankruptcy is long and steep, and requires everyone to pitch in—so it is that the city is filing 185 suits against some of its vendors in an effort to recover as much as $50 million paid to various firms in the months preceding its filing for chapter 9 municipal bankruptcy. According to Chuck Raimi, deputy corporation counsel, Detroit plans to file the suits for what he termed “preferential payments” which were made on account of past-due debts within 90 days prior to the city’s July 18, 2013, bankruptcy filing. The issue? Mr. Raimi argues fairness: the city paid those vendors more than other similarly situated creditors, so that, as he noted in his statement: “The city’s position is that the payments are recoverable as ‘preferences’ under the Bankruptcy Code…The firms in total received about $50 million in the 90 days before the bankruptcy filing.” The Motor City, whose plan of debt adjustment and thereby exit from municipal bankruptcy U.S. Bankruptcy Judge (now retired) Steven Rhodes approved a year ago, says it will attempt to settle the cases prior to a trial. In the nonce, Detroit has asked the federal bankruptcy court to temporarily suspend the vendors’ obligation to formally answer the complaints—the key is the stipulation in chapter 9 municipal bankruptcy of time limitations—so that Detroit was required to file any actions prior to this Saturday.

In a sense, the issue is about equity: trying to ensure that each and every creditor is dealt with fairly and to prevent certain of a municipality’s creditors from receiving a greater share of such municipality’s resources than others that are similarly situated—or that there is as much equity as possible in distribution of a municipality’s proceeds among similarly situated creditors, so that, typically, a portion of a city’s recovered resources would go toward funding payment of the unsecured creditors under the plan.

Striving to Climb Out of Debt. In testimony before the Senate Judiciary Committee, Puerto Rico Gov. Alejandro García Padilla yesterday testified the U.S. territory would give some of its debts priority over others, because, without recourse to municipal bankruptcy, Puerto Rico has reached a debt precipice where it has no choice remaining but to give some of its debts priority over others. Thus, the government has commenced clawing back revenue from certain non-general obligation full faith and credit bonds as a means of avoiding default on $355 million of Government Development Bank notes—or, as the governor testified: “Starting today, the commonwealth will have to claw back revenues pledged to certain bond issues in order to maintain essential public services…In light of the rapidly deteriorating revenue situation, in accordance with Article 6, Section 8 of the constitution of the Commonwealth of Puerto Rico, I ordered the ‘claw back’ of revenues assigned to certain instrumentalities of the commonwealth for the repayment of their debts. Together these instrumentalities have approximately $7 billion in bonds outstanding. In simple terms, we have begun to default on our debt in an effort to attempt to repay bonds issued with the full faith and credit of the commonwealth and secure sufficient resources to protect the life, health, safety and welfare of the people of Puerto Rico.”

Indeed, shortly after Gov. Padilla testified, the Government Development Bank for Puerto Rico reported it had paid all $355 million in debt service due on its notes. Thus, the testimony came at a pivotal moment as Puerto Rico is seeking to restructure about $70 billion of public sector bond debt—debt which the Governor testified is unpayable unless the economy improves. It also means that in the face of looming default, revenues have been diverted from the Puerto Rico Highways and Transportation Authority, the Infrastructure and Finance Authority, the Metropolitan Bus Authority, the Integrated Transportation Authority, and the Convention District Authority. Gov. Padilla, according to a statement from his office, had tried to negotiate with the insurers of some of Puerto Rico’s debt maturing yesterday, but no agreement was reached—or, as his Chief of Staff explained: “The administration’s priority has always been and will always be the welfare of Puerto Ricans, so while we tried to negotiate with the insurers of our bonds to refinance the payment that was due today, the terms and conditions that they wanted to impose on us were unacceptable to the government.”

In his testimony, Gov. Padilla noted that the “magnitude of the fiscal and economic problems bearing down on Puerto Rico are simply too large,” and that, with default imminent, the government had no choice but to choose between paying back creditors versus providing essential public services: “Commencing today, the Commonwealth will have to claw back other income sources in order to maintain essential public services. We have taken this step in the trust that Congress will act…But do not be misled. We have no resources left. Puerto Rico cannot keep this up longer.” Neither the Chair, nor other members of the Senate Committee asked any questions—nor provided any indication in Congress’ waning days of this session whether the Gov. could expect any response or action, notwithstanding the looming $945 million of total Puerto Rican municipal bond payments coming due on Jan. 1st.

The Senate Committee heard testimony from a second panel of five experts with remarkably different perspectives Puerto Rico’s fiscal sustainability, ranging from Professor Carlos Colón de Armas, of the University of Puerto Rico, who testified that Puerto Rico has the money to honor its debt commitment as originally contracted to Stephen Spencer, who represents funds such as OppenheimerFunds and Franklin Advisors in negotiations over the Puerto Rico Electric Power Authority debt, who strongly opposed providing Puerto Rico with recourse to municipal bankruptcy, claiming it would be harmful to the many retail investors both in Puerto Rico and the mainland U.S. that have holdings in Puerto Rico debt—adding that Detroit could be considered as proof that municipal bankruptcy can harm a city’s future access to the capital markets—adding: Detroit “wasn’t a bankruptcy, it was a stickup.”

Alternatives to Chapter 9. Given the apparent unwillingness to consider amending federal bankruptcy law to give Puerto Rico access to bankruptcy, other witnesses suggested alternatives: Alex Pollack, a resident fellow with the American Enterprise Institute, testified the best option would be an emergency federal control board, such as were successfully used for Washington, D.C. and New York City—indeed, Mr. Pollack was speaking on a panel with a former such control board overseer, former New York Lieutenant Governor and a member of the current Michigan oversight panel for Detroit, Richard Ravitch. Mr. Ravitch told the committee the best solution would be a municipal bankruptcy rubric which would modify the current federal 9 municipal bankruptcy law so that it could apply to the Commonwealth. Finally, Richard Carrión, executive chairman of Banco Popular in San Juan, recommended a three-part solution plan which would provide for bankruptcy, a control board, and some type of stimulus for the economy.

Gov. García Padilla and Rep. Pedro Pierluisi (Puerto Rico) urged the Committee to act on legislation which would offer the commonwealth a structured process through which it could resolve its debts, such as municipal bankruptcy, for Puerto Rico’s public authorities, noting that were Congress to act swiftly to pass a package of legislation to permit the U.S. territory to restructure its debt and provide improved healthcare and tax credit practices, he would agree to greater federal oversight – a concept which heretofore has been met with contempt from Puerto Rico officials.

The committee did not invite the administration to testify. The Obama administration has proposed a plan under which indebted governmental agencies, such as the island’s public power company, would be eligible to file for bankruptcy—just as any U.S. corporation may, and would provide for a restructuring of other debts and pension obligations. Under the proposed plan, the federal government would also oversee the territory’s future public spending, and residents of the territory, all U.S. citizens, would gain full access to various anti-poverty programs—programs currently which are less generous there than on the mainland.

The Alternative? With time running out both for Puerto Rico and for this session of Congress, continued inaction by Congress could well accelerate the withering of Puerto Rico’s economy and the exodus of those of its U.S. citizens who can find a way to move to the mainland. It seems, in some ways, almost reminiscent of East Berlin: economic opportunity is shrinking, in part because of federal policy, thus, more than 200 Puerto Ricans are moving to the mainland every day—adding to an economic whirlpool, because it appears to be that those most able to leave and most able to find a job on the mainland are departing—leaving those least able to relocate behind: today there are more Puerto Ricans on the mainland than in Puerto Rico. The exodus also creates a separate fiscal sustainability issue: public pension liabilities: the island’s pension program has sufficient funds to cover just 0.7 percent of its future obligations. The departure of those most able to find employment elsewhere risks widening that fiscal chasm.

Turning a Deaf Ear. If Congress refuses to act, it seems likely Puerto Rico’s leaders will have little option but to raise taxes—even as those most able to pay are seeking to leave—and the territory’s crippling 40 percent poverty level increase—so that there would be greater pressure for essential services, but a growing erosion of revenues. One can imagine a whirlpool now brought on by a shrinking tax base triggering ever higher taxes and reduced essential services, prompting still further emigration—likely triggering a humanitarian crisis. As American citizens, Puerto Ricans, whether on the island or newly moving to the mainland, will be eligible for public support, so that there can be little question but that the federal government will end up bearing much of the cost of Puerto Rico’s past profligacy. The question thus becomes when and how might be the most critical and effective way to provide such assistance.

Scouts’ Honor. Two former JPMorgan bankers have agreed not to violate securities laws and to repay money they made while working on transactions that ultimately thrust Jefferson County, Ala., into bankruptcy, according to documents filed by the Securities and Exchange Commission: The SEC entered consent agreements that Douglas MacFaddin and Charles LeCroy approved into court records in Birmingham, along with a motion requesting that federal Judge Abdul K. Kallon approve the judgments that will end the five-year-old case. Both men agreed, without admitting or denying charges, to injunctions against future violations of all five counts sought in the SEC lawsuit, which centers around sewer warrant transactions and swaps. Mr. MacFaddin agreed to pay a disgorgement of $201,224, including interest; Mr. LeCroy agreed to pay a disgorgement of $125,149, including interest, with both men having agreed to made payments within a year. The decision comes in the wake of the SEC’s November 2009 civil suit alleging that Messieurs LeCroy and MacFaddin improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers.” The lawsuit sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of the violations, plus interest.

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