April 17, 2018
Good Morning! In this morning’s eBlog, we try to assess the fiscal and future governance options for Puerto Rico: will it become a second class state? A nation? Or, at long last, an integral part of the nation? And governance: who is in charge of its governance?
Before Hurricane Maria wracked its terrible human, fiscal, and physical toll; more than 50% of Americans knew not that Puerto Ricans were U.S. citizens. Still, today, some six months after the disaster, more than 50,000 have no electricity. The fiscal and physical toll on low-income Americans on the island has been especially harsh: of the nearly 1.2 million applications to FEMA for assistance to help fix damaged homes, nearly 60% have been rejected: FEMA provided no assistance, citing the lack of lack of title deeds or because the edifices in need were constructed on stolen land or in contravention of building codes. That is to write that this exceptionally powerful storm took a grievous toll not just on life and limb, but especially on the local and state economy, destroying an estimated 80% of Puerto Rico’s agricultural crop, including coffee and banana plantations—where regrowing is projected to take years. The super storm devastated 20% of businesses—today an estimated 10,000 firms remain closed. Discouragingly, the government forecasts output will shrink by another 11% in the year to June 2018.
It might be, ojala que si (one hopes) that a burst of growth will ensue, with estimates of as much as 8% next year, in no small part thanks to federal recovery assistance and as much as $20 billion in private-insurance payments—as well as Puerto Ricans dipping into their own savings to make repairs to their own homes and businesses. Yet, even those positive signs can appear to pale against the scope of the physical misery: by one estimate, Puerto Rico and the U.S. Virgin Islands will lose nearly $48 billion in output—and employment equivalent to 332,000 people working for a year. Of perhaps longer term fiscal concern are the estimated thousands of Puerto Ricans who left the island for Florida and other points on the mainland—disproportionately those better educated and with greater fiscal resources—leaving behind older and poorer Americans, and a greater physical and fiscal burden for Puerto Rico’s government.
The massive storm—and disparate treatment by the Trump administration and Congress—have encumbered Puerto Rico with massive debts, both to its central government and municipalities, but also to its businesses. Encumbered with massive debts—including $70 billion to its municipal bondholders and another $50 billion in public pension liabilities; Governor Ricardo Rosselló’s administration is making deep cuts: prior to the massive storm, the government had been committed to slashing funding to its local governments by $175 million, closing 184 schools, and cutting public pensions—pensions which, at just over $1,000 are not especially generous. Now, that task will be eased, provided the PROMESA oversight Board approves, to moderate the proposed cuts in services in order to do less harm the reviving economy.
Assisted by federal tax incentives, Puerto Rico’s economic model was for decades based on manufacturing, especially of pharmaceuticals. However, what Congress can bestow; it can take away. Thus it was that over the last decade, Congress steadily eroded economic incentives—Congressional actions which contributed to the territory’s massive debt crisis, and contributing to the World Bank dropping Puerto Rico 58 places in its ranking compared to the mainland with regard to the ease of doing business.
The havoc wreaked by Maria could be especially creative for the island’s private sector, which represents a chronically missed opportunity. Puerto Rico, for all its problems, is a beautiful tropical island, with white-sanded beaches, rainforest, fascinating history, lovely colonial buildings and a vibrant mix of Latin-American and European culture. Yet, with 3.5 million visitors a year, its tourism industry is less than half the size of Hawaii’s. It has an excellent climate for growing coffee and other highly marketable products, yet its agriculture sector is inefficient and tiny. The island has a well-educated, bilingual middle-class, including a surfeit of engineers, trained at the well-regarded University of Puerto Rico for the manufacturing industry, and cheap to hire. But in the wake of the departing multinationals, they are also leaving. Isabel Rullán, a 20-something former migrant, who has returned to the island from Washington to try to improve linkages to the diaspora, estimates that half her university classmates are on the mainland.
Quien Es Encargado? (Who is in charge?) Unlike a normal chapter 9 municipal bankruptcy proceeding, the process created by Congress under the PROMESA law created a distinct governance model—one which does create a quasi emergency manager, but here in the form of a board, the PROMESA Board, which, today, will submit its proposed fiscal plan, or quasi plan of debt adjustment to U.S. Judge Laura Swain Taylor; it will maintain its requirement to propose the reduction of the public pensions of Puerto Ricans by an average of 10 percent. Until last weekend, the PROMESA Board had kept under review the complaints to Governor Ricardo Rosselló with regard to the inclusion in its revised fiscal plan of the central government the base of a labor reform which, among other proposals, calls for the immediate reduction in vacation and sick leaves from 15 to 7 days for workers of private companies, according to two sources close to the Board. Under the fiscal plan proposed by the Governor Rosselló, the cuts would reach $1.45 billion in five years. The PROMESA Board has requested that they total $1.58 million by June of 2023. The proposal, unsurprisingly, has raised questions with regard to whether the Congress has the authority to impose on the government of Puerto Rico a reform of its labor laws—any more than its inability under our form of federalism to dictate changes in any state’s retirement systems—contracts which are inherent in state constitutions.
Pension reductions in chapter 9 cases, because they involve contracts, are difficult, as contracts are protected under state constitutions—moreover, as we saw in Detroit’s plan of debt adjustment approved by now retired U.S. Bankruptcy Judge Steven Rhodes, the court wanted to ensure that any such reductions would not subject the retiree to income below the federal poverty level—a level which, Puerto Rico Governor Ricardo Rossello told Reuters, in an interview this past week, “many retirees are already under,” as he warned that any further pension cuts could “cast them out and challenge their livelihood.” That is, in the U.S. territory struggling with a 45 percent poverty rate and unemployment more than double the U.S. national average, the fiscal challenge of how to restructure nearly $70 billion in debt, where public pensions, which owe $45 billion in benefits, are also virtually insolvent, makes the challenges which had confronted Judge Rhodes pale in comparison. Moreover, with the current pensions already virtually insolvent, paying pension benefits out of Puerto Rico’s general fund, on a pay-as-you-go basis, could cost the virtually bankrupt Puerto Rico $1.5 billion a year. The PROMESA Board has recommended that Gov. Rossello reduce pensions by 10 percent.
For their part, the island’s pensioners have formed a negotiating committee, advised by Robert Gordon, an attorney who advised retirees in Detroit’s chapter 9 municipal bankruptcy, as well as Hector Mayol, the former administrator of Puerto Rico’s public pensions. The fiscal challenge in Puerto Rico, however, promises to be more stiff than Detroit—or, as Moody’s put it: Puerto Rico’s “unusual circumstances mean that it will not conform exactly” to recent public bankruptcies, in which “judges reduced creditor claims far more than amounts owed to pensioners.” Moreover, the scope or size of Puerto Rico’s public pension chasm is exacerbated by the ongoing emigration of young professionals from Puerto Rico to the mainland—making it almost like an increasingly unbalanced teeter totter. The U.S. territory’s largest public pension, the Employee Retirement System (ERS), which covers nearly 100,000 retirees, is projected to run out of cash this year: it is confronted by a double fiscal whammy: in addition to paying retiree benefits, ERS owes some $3.1 billion to repay debts on municipal bonds it issued in 2008—bonds issued to finance Puerto Rico’s public pension obligations. Last year, Governor Rosselló had agreed to a reduction in pensions for government retirees, indicating a willingness to seek as much as a 6% reduction. That appears not, however, to be something he currently supports.
A few weeks ago, in the wake of negotiations with the PROMESA Board, Governor Rosselló proposed a labor reform similar to the one he negotiated with members of the Board, with differences with regard to how to balance it with an increase in the minimum wage and when to implement such changes. The Governor, however, withdrew the proposal when the Board required that the labor reform be in full force by next January, instead of applying it gradually over the next three years, and conditioned the increase from $ 7.25 to $ 8.25 per hour in the minimum wage to the increase in labor participation rates. It seems the PROMESA Board is intent upon labor reform as an essential element for future economic growth.
The Challenge of “Shared” Governance. Unlike in Central Falls, San Bernardino, Detroit, Jefferson County, or other chapter 9 cases where state enacted chapter 9 statutes prescribed governance through the process, the PROMESA statute created a territorial judicial system to restructure Puerto Rico’s public debt, creating a Board empowered to reign until four consecutive balanced budgets and medium and long-term access to the financial markets are achieved—or, as our colleague and expert, Gregory Makoff, of the Center for International Governance Innovation, who worked for a year as an advisor to the Department of Treasury in the Puerto Rican case, put it: “While the lack of cooperation with the Board may be good in political terms in the short-term, it simply delays the return of confidence and extends the time it will take for the Oversight Board to leave the island.” Mr. Makoff has recommended the Board and Gov. Rosselló propose to Judge Swain a cut of from $45 down to $6 billion of the public debt backed by taxes, with a payment of only 13.6 cents per each dollar owed, with the intent of equating it with the average that the states have. His suggestion comes as the Board aims to disclose its plans as early as this evening in advance of its scheduled sessions at the end of the week at the San Juan Convention Center, where, Thursday, the Board wants to certify Puerto Rico’s and PREPA’s proposed plans, and then, Friday, vote on the plans of the other public corporations: the Aqueducts and Sewers Authority (PRASA), the Highways and Transportation Authority (PRHTA), the Government Development Bank, the University of Puerto Rico (UPR) and the Cooperatives Supervision & Insurance Corporation (COSSEC).
Fiscal Balancing. The PROMESA law authorizes the Board the power to impose a fiscal plan and propose to Judge Swain a quasi plan of debt adjustment, as under chapter 9, on behalf of the government, much as in a chapter 9 plan of debt adjustment‒albeit the PROMESA statute does not grant the Board the power to enact laws or appoint or replace government officials. The Congressional act retained for the government of Puerto Rico the capacity and responsibility to enact laws consistent with the fiscal plan and the fiscal adjustment plan, as well as, obviously, to operate the government.
The Promise & Unpromise of PROMESA: Who Is Encargado II? Unlike in a, dare one write “traditional” chapter 9 municipal bankruptcy, where state enacted legislation defines governing authority in the interim before a municipality receives approval of its plan of debt adjustment to exit municipal bankruptcy, the Congressional PROMESA statute has left blurred the balance—or really imbalance—of authority between the power of the Board to approve a budget and fiscal plans, with its possible lack of authority to implement reforms, such as changes to federal regulations it promotes. An adviser to House Natural Resources Committee Chairman Rob Bishop ((R-Utah) recently noted that if the Rosselló administration does not implement the labor reform proposed by the PROMESA Board, the option for the Board would be to further reduce the expenses of the government of Puerto Rico—or, as Constitutional Law Professor Carlos Ramos González, at the Interamerican University of Puerto Rico, describes it, notwithstanding the impasse, “in one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.” An adviser to Chair Bishop said recently that if Gov. Rosselló’s administration does not implement the labor reform proposed by the Board, the option for the PROMESA Board would be to further reduce the expenses of the government of Puerto Rico—or, as Professor González put it: “In one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.”
The Uncertain State of the State. An ongoing challenge to full recovery for Puerto Rico is its uncertain status—a challenge that has marked it from its beginning: in February of 1917, during debate on the Senate floor of HR 9533 to provide for a civil government for Puerto Rico, when Sen. James Wadsworth (R-N.Y) inquired of Senate sponsor John F. Shafroth of Colorado whether it would “provide woman suffrage in Puerto Rico?” Sen. Shafroth made clear his intent that the eligibility of voters in Puerto Rico—as in other states—“may be prescribed by the Legislature of Puerto Rico.” That debate, more than a century ago, lingers as what some have described as “the albatross hanging around the island’s neck: the uncertainty over its status.” Is it a state? A country? Or some lesser form of government? Even though thousands of Puerto Ricans have fought and died serving their country in World Wars I and II, in Vietnam and Afghanistan, Puerto Rico has never been treated as a state—and its own citizens have been unable to decide themselves whether they wish to support statehood.
Some believe Puerto Rico will become a state eventually. But to get there, especially without risking a violent nationalist repulse, Puerto Rico needs to understand what the federal requirements and barriers will be—and what the promise of PROMESA really will mean. And, as they used to say in Rome: tempus fugit. Time is running out: for, absent economic and fiscal recovery soon, the flood of emigration of young Americans from Puerto Rico will become a brain-drain boding a demographic death-spiral, leaving the island with too few taxpayers to cover its more rapidly growing health care costs for an aged population.