The Indelicate Challenge of Restoring Political Authority in the Wake of Municipal Insolvency

Good Morning! In this a.m.’s eBlog, we consider the historic Civil War municipality of Petersburg’s, Virginia’s steps back to solvency and restoration of municipal control, and then to the indelicate imbalance of fiscal power in Puerto Rico—and whether the federal preemption might be causing more fiscal damage to its fiscal future.

Returning to Solvency. The Petersburg, Virginia City Council last night approved its FY2018 budget, a budget which includes outsourcing jobs—with more than a dozen city employees slated to lose their jobs as a result. The new municipal budget includes an increase in water rates—an increase of nearly 15%–an increase the city’s elected officials deemed necessary in order to finance needed repairs, as well as to update its systems for billing and collections—and to cover its past due arrears of $1.9 million. The session came as the Council began discussions with regard to hiring a new city manager and police chief—and whether to beef up is personal property tax enforcement: the city estimates it could be losing as much as $7 million annually from inadequate collection efforts. The actions by the Mayor and Council reflect a restoration of municipal authority in the wake of state intervention.

The Unpromise of PROMESA? Neither the government of Puerto Rico, nor the PROMESA Oversight Board has been able to state how much in municipal bond interest payments will be made for the next fiscal year—even as the gates of the University of Puerto Rico have been locked, depriving the U.S. territory of the jewel in its crown. The University, which has relied upon 30% of its financing from the government—financing critical to Puerto Rico’s hopes to keep its most promising future generation on the island, rather than incentivized to leave for New York City or Miami—increasingly threatening to leave behind an older and less educated population, more dependent on governmental services, but less able to pay taxes. However, as the PROMESA Board struggles over its preemptive decision with regard to what percent of Puerto Rico’s debt obligations to its municipal bondholders should be mandated, (according to the Board’s March approved fiscal plan, the bonds most closely associated with Puerto Rico’s government would pay $404 million in debt service in the coming fiscal year—approximately one-eighth of the $3.28 billion debt service due), the question with regard to investing in Puerto Rico’s fiscal and physical future remains murky—indeed, murky enough that the balance between Puerto Rico’s $404 million in debt service costs versus investments in its future has been left hanging.

Part of the challenge of preemptive governance is, as we perceived in the first instance of the Michigan takeover of Flint, that there can be signal human and fiscal damage to life, property, and fiscal solvency. Thus, the imbalance where the federal takeover under PROMESA, the Act intended to serve as the fiscal guide through FY2026, is to what extent disinvestment in Puerto Rico’s physical infrastructure and its municipalities might aggravate, rather than restore the territory’s solvency and create a fiscal foundation for its future. And that future is at stake—a future where the gates of its premier university are locked, and where demographers report the loss of population of 61,874 in one year—and where last Sunday’s plebiscite witnessed a drop of more than 50% in voter participation, with markedly reduced percentages in Puerto Rico’s 78 municipalities—where participation was 23%, less than a third the level of 1998. Demographer Raúl Figueroa noted: “The population is declining…To give people an idea, from 2015 to 2016, the loss of population was 61, 874,” adding that every year between 1% and 2% of the population is lost. The Mayors of Yauco (a municipality which lost nearly 10% of its population over the last decade) and Ponce, Puerto Rico’s second largest city, known as the City of Lions (population of 194,636), founded in 1692, an important trading and distribution center, as well as a key port of entry—indeed, one of the busiest ports in the Caribbean, which has seen a 9.36% decline in its population—a decline which Mayor Maria Mayita Meléndez, attribute to emigration: Mayor Meléndez notes that since 2006, more than 25,000 Puerto Ricans have left Ponce.

Elections, Federalism, & Inequitable Fiscal Outcomes

Good Morning! In this a.m.’s eBlog, we consider yesterday’s overwhelming vote in Puerto Rico for statehood—and why that will likely be ignored with less equitable fiscal implications.

Federally Sanctioned Fiscal Inequity? In the fifth such vote on a non-binding referendum, Puerto Ricans, yesterday, overwhelmingly, voted for statehood—sending the issue back again to Congress—which, last time, in 2012, opted not to act.  In order for Puerto Rico to become the nation’s 51st state, Congress would have to act. 502,616 voted for statehood, against 7,779, who voted in favor of independence, and 6,821 to retain the current territorial status 6,821. Gov. Ricardo Rosselló, in the wake of the vote, noted: “Today Puerto Ricans are sending a strong and clear message to the world, claiming equal rights as American citizens…It is now up to us to bring those results to Washington with the strength of democratic exercise, supervised by a Mission of National and International observers: this mission will be reporting to Congress and the federal government on this historic election.”  

Since Puerto Rico became a U.S. territory after the Senate, on February 20, 1917, voted in support of H.R. 9533, to “provide a civil government for Puerto Rico.” The Act, falling between statehood and colonial status, has meant that Puerto Rico has remained in quasi-colonial status, with less favorable shipping laws than neighboring nations and less equitable treatment under Medicaid for its citizens—notwithstanding their U.S. citizenship. Moreover, it has meant Puerto Rico is entitled to no representation in the U.S. Senate—and has only a non-voting delegate in the U.S. House of Representatives. Similarly, because it is not defined as a state, Puerto Rico does not receive entitlement funding for Medicare—as do the fifty states.

The outcome is almost certain to be ignored by the White House and Congress. It leaves Puerto Rico’s efforts to restructure its nearly $120 billion in debt—some six times what Detroit faced in the largest municipal bankruptcy in. U.S. history—in a quasi-colonial status, where current federal laws provide competing Caribbean nations with more favorable trade status, but less favorable costs for shipping, as well far less in Medicaid assistance compared to states.

The British Broadcasting Service, the Beeb, posits that a GOP-led Congress is wary of acting on the vote, because it would likely mean adding two Democratic votes in the closely-divided U.S. Senate—as well as opening the fiscal gates for equitable treatment on a par with the other 50 states.  

A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

The Knife Edges of Municipal Bankruptcy

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Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal pipeline to the recovery for the City of Flint, the outcome of a Pennsylvania grand jury investigation of the near municipally bankrupt Pennsylvania capital city of Harrisburg, before addressing the .growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico.

In Like Flint? The Michigan legislature has finally agreed to appropriate $20 million to make the requisite match in order for some $100 million in federal aid to go to the city, with the funds to be used to replace corroded pipes which leached lead into the city’s drinking water system, creating not just grave health repercussions, but also devastating the city’s assessed property values and public safety budgets. The city’s near insolvency, which had come in the wake of the decisions which lead to the water contamination by a gubernatorially appointed Emergency Manager, may mark one of the final chapters to the city’s physical and fiscal recovery.

A State Capital’s Near Bankruptcy. Pennsylvania’s capital city, Harrisburg, chartered as a city the year the Civil War commenced, which came close to filing for chapter 9 municipal bankruptcy, will, in its proposed budget for the upcoming fiscal year, follow a court-approved bankruptcy plan, with slightly more revenues than expenditures, except that the city does not expect to be able to hire police as fast as called for in its budget. At a workshop this week, the first of several planned before the City Council votes on the budget for FY2017-2018, the proposed plan proposes minimal increases in most departments, as total revenue is expected to climb to $119.86 million, an increase of about $7 million from last year. City Manager Mark Scott, in a memo to the Council prior to its consideration of the budget, wrote: “In developing our budget recommendations, it is obvious we do not have anywhere near the money we would like to have…Nor is that likely to change any time soon. We cannot expect to address our future by replicating our past. We will have different staffing than in the past and different service delivery expectation. Right now, we are budgeting to establish a solid base—meaning staff skill sets and new, efficient systems/processes.”

In the city, where taxpayers and residents, as well as city officials, consistently list public safety as a top priority, Harrisburg’s five-year plan to increase spending on police was a keystone of the city’s plan of debt adjustment, which was officially confirmed in February. Nevertheless, while the Police Department budget, at $72 million, meaning it is more than 60 percent of the total general fund budget, calls for a significant increase in hiring, and recruiting. City Manager Mark Scott, however, warned that the issue involves more than the budget: “We’re getting people into the academy as fast as we can,” as he advised he hopes the city to realize “a net increase of 18 officers by the end of the year.” Following a trend that began before the 2012 bankruptcy filing, the city again plans to have fewer employees than the year before. This year, however, that is primarily due to the new voter-approved city charter, which transfers sewer workers from the city to the independent Water Department: the new budget authorizes 746 positions, compared to 763 one year earlier.

Tropical Fiscal Typhoon. Puerto Rico, the insolvent U.S. territory, is trapped in a vicious fiscal and physical whirlpool where the austerity measures it has taken to meet its fiscal obligations to its creditors all across the U.S. have come at a steep fiscal and physical cost: some 30,000 public sector employees have lost their jobs, even as the nearly 75% increase in its sales and use tax has backfired: it has served to curtail shopping, adding to the vicious cycle of increasingly drastic fiscal steps in an effort to make payments to bondholders on the mainland—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006. Over this period, the poverty rate has grown to 45%, while the demographic imbalance has deteriorated with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly five times greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Now, with U.S. District Court Judge Laura Taylor Swain set to preside next Wednesday (Financial Oversight and Management Board of Puerto Rico, 17-cv-01578), we will witness a unique trial, comparable to those in Jefferson County, Detroit, Stockton, San Bernardino, etc.; however, here there will be differences compared to chapter 9, as there will be roles for both Puerto’s Rico, but also the PROMESA oversight board—with, presumably, both seeking a fiscal recovery, but unlikely to have comparable proposals with regard to the most appropriate and effective plan of debt adjustment. Perhaps the greatest challenge will be economic recovery: for Detroit, whose bankruptcy pales in comparison to Puerto Rico’s; Detroit was able to benefit from a constructive state role and an economy vastly boosted by the federal bailout of its gigantic auto industry. That contrasts with current federal laws discriminating against Puerto Rico’s economy vis-à-vis competitor Caribbean nations, and caught in a Twilight Zone between a state and municipality, with a stream of its young talent streaming to Miami and New York, leaving behind a demographic map of poverty, empty classrooms, and aging people—and dependent on sales taxes, but with sharp reductions in pensions almost certain to sharply and adversely affect sales tax revenues. Judge Taylor will require the wisdom and strength of Job.

Solomon’s Choices: Who Will Define Puerto Rico’s Fiscal Future–and How?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy. 

Tropical Fiscal Typhoon. U.S. Supreme Court Chief Justice John Roberts has selected Southern District of New York Judge Laura Taylor Swain, who previously served as a federal bankruptcy Judge for the Eastern District of New York from 1996 until 2000 to preside over Puerto Rico’s PROMESA Title III bankruptcy proceedings—presiding, thus, over a municipal bankruptcy nearly 500% larger than that of Detroit’s–one which will grapple with creating a human and fiscal blueprint for the future of some 3.5 million Americans—and force Judge Swain to grapple with the battle between the citizens of the country and the holders of its debt spread throughout the U.S. (Title III of PROMESA, which is modeled after Chapter 9 of the Municipal 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.

The action came in the wake of Puerto Rico’s announcement last week that it was restructuring a portion of its nearly $73 billion in debt—an action which it was clear almost from the get-go that the requisite two-thirds majority of Puerto Rico’s municipal bondholders would not have supported. (Puerto Rico’s constitution provides that payments to holders of so-called “general obligation” bonds have priority over all other expenditures—even as another group of creditors has first access to revenues from the territory’s sales tax.) More critically, Judge Swain will be presiding over a process affecting the lives and futures of some 3.5 million Americans—nearly 500% greater than the population of Detroit. And while the poverty rate in Detroit was 40%, the surrounding region, especially after the federal bailout of the auto industry, differs signally from Puerto Rico, where the poverty rate is 46.1%–and where there is no surrounding state to address or help finance schools, health care, etc. Indeed, Puerto Rico, in its efforts to address its debt, has cut its health care and public transportation fiscal support; closed schools; and increased sales taxes. With the Bureau of Labor Statistics reporting an unemployment rate of at 12.2%, and, in the wake of last year’s Zika virus, when thousands of workers who were fighting the epidemic were let go from their jobs; the U.S. territory’s fiscal conditions have been exacerbated by the emigration of some of its most able talent—or, as the Pew Research Center has noted:  “More recent Puerto Rican arrivals from the island are also less well off than earlier migrants, with lower household incomes and a greater likelihood of living in poverty.”

For Judge Swain—as was the case in Detroit, Central Falls, San Bernardino, Stockton, etc., a grave challenge in seeking to fashion a plan of debt adjustment will resolve around public pensions. While the state constitutional issues, which complicated—and nearly led to a U.S. Supreme Court federalism challenge—do not appear to be at issue here; nevertheless the human aspect is. Just as former Rhode Island Supreme Court Judge Robert G. Flanders, Jr., who served as Central Falls’ Receiver during that city’s chapter 9 bankruptcy—and told us, with his voice breaking—of the deep pension cuts which he had summarily imposed of as much as 50%—so too Puerto Rico’s public pension funds have been depleted. Thus, it will fall to Judge Swain to seek to balance the desperate human needs on one side versus the demands of municipal bondholders on the other. Finally, the trial over which Judge Swain will preside has an element somewhat distinct from the others we have traced: can she press, as part of this process to fashion a plan of debt adjustment, for measures—likely ones which would have to emanate from Congress—to address the current drain of some of Puerto Rico’s most valuable human resources: taxpayers fleeing to the mainland. Today, Puerto Rico’s population is more than 8% smaller than seven years ago; the territory has been in recession almost continuously for a decade—and Puerto Rico is in the midst of political turmoil: should it change its form of governance: a poll two months’ ago found that 57% support statehood. Indeed, even were Puerto Rico’s voters to vote that way, and even though the 2016 GOP platform backed statehood; it seems most unlikely that in the nation’s increasingly polarized status the majority in the U.S. Congress would agree to any provision which would change the balance of political power in the U.S. Senate.

Is There a PROMESA of Recovery?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy, after which we journey north to review the remarkable fiscal recovery from chapter 9 municipal bankruptcy of one of the nation’s smallest municipalities.

Tropical Fiscal Typhoon. Puerto Rico is trapped in a vicious fiscal whirlpool where the austerity measures it has taken to meet short-term obligations to its creditors all across the U.S., including laying off some 30,000 public sector employees and increasing its sales tax by nearly 75% have seemingly backfired—doing more fiscal harm than good: it has devastated its economy, depleted revenue sources, and put the government on a vicious cycle of increasingly drastic fiscal steps in an effort to make payments—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006, while its poverty rate has grown to 45%. At the same time, a demographic imbalance has continued to accelerate with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly 500% greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Thus, with the island’s hedge-fund creditors holding defaulted municipal general obligation bonds on the verge of completing a consensual agreement earlier this week, the PROMESA oversight board intervened to halt negotiations and place Puerto Rico under the Title III quasi municipal bankruptcy protection. That will set up courtroom confrontations between an impoverished population, wealthy municipal bondholders in every state in the domestic U.S., and hedge funds—pitted against some of the poorest U.S. citizens and their future. Nevertheless, as Congress contemplated, the quasi-municipal bankruptcy process enacted as part of the PROMESA statute provides the best hope for Puerto Rico’s future.

Thus the PROMESA Board has invoked these provisions of the PROMESA statute before a federal judge in San Juan, in what promises to be a long process—as we have seen in Detroit, San Bernardino, and other cities, but with one critical distinction: each of the previous municipal bankruptcies has involved a city or county—the quasi municipal bankruptcy here is more akin to a filing by a state. (Because of the dual federalism of our founding fathers, Congress may not enact legislation to permit states to file for bankruptcy protection.) Unsurprisingly, when Puerto Rico was made a U.S. territory under the Jones-Shafroth Act, no one contemplated the possibility of bankruptcy. Moreover, as chapter 9, as authorized by Congress, only provides that a city or county may file for chapter 9 bankruptcy if authorized by its respective state; Puerto Rico inconveniently falls into a Twilight Zone—to write nothing with regard to access to such protections for Puerto Rico’s 87 municipalities or muncipios.

Moreover, while from Central Falls, Rhode Island to Detroit, the role of public pension obligations has played a critical role in those chapter 9 resolutions; the challenge could be far greater here: in Puerto Rico, retired teachers and police officers do not participate in Social Security. Adopting deep cuts to their pensions would be a virtual impossibility. So now it is that Puerto Rico will be in a courtroom to confront hedge funds, mutual funds, and bond insurers, after the negotiations between Puerto Rico and its creditors over a PROMESA Board-approved fiscal plan that allocates about $787 million a year to creditors for the next decade, less than a quarter of what they are owed, was deemed by said creditors to be a slap in the face—with the Board having pressed for a combination of debt restructuring spending cuts in its efforts to revive an economy trapped by a 45% poverty rate—and where the Board had proposed upping water rates on consumers, liquidating its decades-old industrial development bank, and seeking concessions from creditors of other government agencies. Moreover, amid all this, Gov. Ricardo Rosselló, who has recently renegotiated to mitigate politically unpopular fee increases on residents, now finds himself nearly transfixed between desperate efforts to sort out governance, meet demands of his constituents and taxpayers, and negotiate with a federally imposed oversight board, even as he is in the midst of a campaign for U.S. statehood ahead of a plebiscite on Puerto Rico’s political status—and in the wake of being named a defendant in a lawsuit by hedge funds after the expiration of a stay on such suits expired this week. Hedge funds holding general obligation and sales-tax bonds filed the suit on Tuesday, naming Gov. Rosselló as a defendant—albeit, the suit, and others, are nearly certain to be frozen, as the main judicial arena now will fall into a quasi-chapter 9 courtroom epic battle. And that battle will not necessarily be able to fully look to prior chapter 9 judicial precedents: while Title III incorporates features of chapter 9, the section of the U.S. bankruptcy code covering insolvent municipal entities, courts have never interpreted key provisions of Title III—a title, moreover, which protections for creditors which chapter 9 does not.

The Rich Chocolatey Road to Recovery! Moody’s has awarded one of the nation’s smallest municipalities, Central Falls, aka Chocolate City, Rhode Island, its second general obligation bond upgrade in two months, a sign of the former mill city’s ongoing recovery from municipal bankruptcy—an upgrade which Mayor James Diossa unsurprisingly noted to be “very important.” Moody’s noted that its upgrade “reflects a multi-year trend of stable operating results and continued positive performance relative to the post-bankruptcy plan since the city’s emergence from Chapter 9 bankruptcy in 2012,” adding that it expects the city will enhance its flexibility when its plan of debt adjustment period ends at the end of next month—at which time one of the nation’s smallest cities (one square mile and 19,000 citizens) will implement a policy of requiring maintenance of unassigned general fund reserves of at least 10% of prior year expenditures. In its upgrade, Moody’s reported the upgrade reflected Central Falls’ high fixed costs, referring to its public pension obligations, OPEB, and debt service–costs which add up to nearly 30% of its budget—and what it termed a high sensitivity to adverse economic trends compared with other municipalities, with the rating agency noting that a sustained increase in fund balance and maintenance of structural balance could lead to a further upgrade, as could a reduction in long-term liabilities and fixed costs and material tax-base and growth.

 

The Fiscal Agony of the Absence of Chapter 9

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy.

Tropical Fiscal Typhoon. With the expiration of the freeze on litigation against the U.S. territory of Puerto Rico expiring yesterday, municipal bondholders filed suit against the Puerto Rico, likely marking the front end of a number of suits in the wake of Puerto Rico’s under the PROMESA law after its default on $1.3 billion of principal owed since the previous Governor declared the $70 billion public debt load unpayable in June of 2015. Bondholders filed two new lawsuits, even as the stay was lifted from at least 13 others. In the suits, the plaintiffs are seeking 11 declaratory judgments, two writs of mandamus, and three permanent injunctions. The fiscal meltdown came against a wavering political backdrop, as a demonstration in Puerto Rico’s capital, San Juan, against the PROMESA board’s austerity measures Monday turned violent: there was extensive damage to a Banco Popular office building’s windows, fires being lit, and car windows being smashed. The newest suits come after the administration of Gov. Ricardo Rosselló was unable to negotiate any agreement with the territory’s municipal bondholders after the May 1st deadline of the litigation freeze. His Chief of Staff, William Villafane, told the AP just hours before the freeze expired that the government preferred to reach a deal with bondholders, adding, however, that a municipal bankruptcy-like process could be an option if negotiations were to fail. A group representing those who bought a portion of the $16 billion worth of municipal bonds backed by Puerto Rico’s sales tax, charged that the government plan to cut its $70 billion debt was unconstitutional; they accused government leaders of perpetrating “unfair, unjust, and illegally punitive terms.” Ambac Assurance Corp. filed its own suit, accusing the government of illegally retaining $300 million owed to bondholders. The suit alleges it had been forced to pay more than $52 million in insurance claims because of ongoing defaults by Puerto Rico’s government. The tropical storm of litigation, coming on top of nearly a dozen lawsuits prior to the freeze imposed under the PROMESA law, came as Aurelius Capital Management LP, and other hedge funds, sued Puerto Rico in New York state court, seeking to recoup past-due payments on some $1.4 billion in defaulted general obligation bonds.

The precipitous storm of litigation appeared to mark the collapse of restructuring negotiations, as well as to signal the PROMESA board will vote to trigger the PROMESA Title III provisions to trigger a quasi-chapter 9 municipal bankruptcy proceeding. The fiscal disruption, at the same time, appeared to come as a physical disruption of riots and active lawsuits, leading the Dean of chapter 9 municipal bankruptcy, Jim Spiotto, to note: “Sometimes it is darkest before the dawn.” Counselor Spiotto added that a “litigation meltdown is not a solution” to the Puerto Rico debt problem; rather, he added: “You may have all the rights in the world, but if the [debtor] party doesn’t survive, thrive, your ability to get repaid is severely diminished,” noting that litigation is the least likely means of reaching a long-term solution, since the debtor is going to be hit by substantial attorney’s fees. Further, he explained, even were the PROMESA Oversight Board to initiate Title III to consolidate all Puerto Rico debt cases into a single quasi-bankruptcy process, that would simply open the way to a long and costly trail of appeals; thus, he notes that instead, all parties need a “time out” if there is to be a realistic chance of a fiscal solution, noting that would almost surely lead to a better outcome for all parties. Or, as U.S. Rep. Nydia Velázquez (D.-NY.) put it: “The power to comprehensively restructure 100 per cent of Puerto Rico’s debt is the reason why I voted ‘yes’ on [PROMESA] last year….Inconceivably, today, May 2, 2017, the island is on the same path as it was prior to the enactment of the law. This is unconscionable. It is imperative the board use this powerful tool and vote to file for a Title III proceeding immediately.”

The fiscal collapse also creates a constitutional and governance crisis. Article VI of Puerto Rico’s constitution (§8) provides that: “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law;” however, Title III of the federal PROMESA statute would supersede this.

The growing challenge spread also, as Ambac filed suit against the U.S. Treasury Secretary Steven Mnuchin, seeking to bar access by the U.S. territory to a federal excise tax imposed on rum manufactured in the territory and sold in the mainland U.S. Moreover, Ambac also filed two other lawsuits over Puerto Rico’s alleged efforts to break the lien securing some $17 billion in sales-tax municipal bonds—one suit in federal court, the other in New York state court. One, in federal court, sought a court order safeguarding the revenue stream that backs those bonds.

Amid the various court challenges, Gerardo Portela, the Executive Director of Puerto Rico’s Financial Advisory and Tax Agency, yesterday claimed: “We are talking to all the different groups of bondholders,” after leaving La Fortaleza after holding a meeting with Governor Rosselló. Moreover, with the increasing threat to critical public services, Puerto Rico Property Secretary Raul Maldonado yesterday provided assurances that the government already has part of the money required by the Fiscal Supervision Board to avoid the reduction of working hours in public employees.

Just to provide some scale of what is unfolding, the quasi chapter 9 municipal bankruptcy here under a federal court-supervised restructuring for a portion of Puerto Rico’s $70 billion debt would be 800% larger than Detroit’s—which to date, has marked the largest chapter 9 bankruptcy in American history. However, with Puerto Rico neither a municipality, nor a state, it falls into a legal and fiscal Twilight Zone. In the wake of bondholder rejection, over the weekend, of an offer to pay 50 cents on the dollar to holders of Puerto Rico general obligation and sales-tax bonds backed by Puerto Rico’s constitution, it increasingly appears a non-federal bankruptcy court will be pressed to try to put Humpty Dumpty back together again.

Meanwhile, in Congress, federal legislation, HR 1366, the U.S. Territories Investor Protection Act of 2017, a bill to try to close a legal loophole which some in Congress believe allowed broker-dealers to defraud Puerto Rico investors was passed on a voice vote by the House and will now move to the Senate for consideration. The legislation would extend all the rules under the Investment Company Act of 1940, which apply, to investment companies on the U.S. mainland to those investment companies operating in Puerto Rico and the other U.S. territories. Rep. Velázquez, in introducing the bill, noted: “Today’s bipartisan action in the House is a huge step for the people of Puerto Rico, and I will keep applying pressure for Senate action.” A companion bill in the Senate (S. 484), sponsored by Sen. Robert Menendez, D-N.J., has already cleared the Senate Banking Committee. The Congresswoman said that the legislators had “acted in the best interest of retirees and individual investors in Puerto Rico,” adding that: “For far too long, Puerto Rican retirees and others have been preyed on by unscrupulous investors who have exploited this disparity in the rules…By passing this measure in the House, we are one step closer to putting an end to these abuses.”