Por Gerardo Carlo-Altieri*
The lack of legislative response from Congress on the worst economic crisis in the history of Puerto Rico, has local politicians disconcerted and the general populace of the island in a state of despair. No one understands why Congress is having such a hard time deciding on a formula acceptable to all parties. At stake is a local government shut-down and the repayment of about $3 billion to bondholders due this year, with each group of creditors having highly conflicting expectations as to their own priorities. The difficulty is not only that the GO’s, COFINAS, and pension creditors are at odds, but that Congress is navigating uncharted waters. The election year frenzy found within the Washington and Puerta de Tierra beltways, and the philosophical and somewhat moralistic differences dividing Congress, complicates the matter.
The issues run deep. Many in Congress still don’t believe that an orderly bankruptcy resolution process, allowing a government entity to “cram down” or modify bondholder debt, should be allowed. The mention of any sort of forced “haircut”, defined as a non-voluntary cut in bond-holder’s principal or interest payments, is considered almost criminal. The possibility of any sort of federal “bailout”, which could legally take the form of loans, bond swaps or federal guarantees for Commonwealth obligations, is considered to violate creditor rights and not a solution to the Island’s problems. Contrary to what occurred with the banks, financial institutions and private companies after the toxic asset meltdown and recession of 2008, any relief for Puerto Rico involving the U.S. taxpayer’s pockets is considered almost sinful and political year suicide.
Behind the opposition to a relief bill from Congress, is the idea that judicial modification of Puerto Rico bondholder payment is unfair, especially if imposed by force and retroactively. Also, Congress seems convinced up to this point that the Island is still not “too big to fail”; but irrespective, no one can really estimate the “domino effect” of a big territorial default on the stability and financial health of the sensitive municipal credit markets. The truth is, that no one in Washington is exactly sure how to deal with a territorial insolvency of the magnitude of the local debt, and excluded from Chapter 9.
Even though a traditional Chapter 9 does not seem to be in the works for the Island, the principles of this insolvency resolution framework loom like a phantom, over discussions on resolution of the local government insolvency. The creditor’s pain, due to possible reduction of principal on government debt, is another driving force behind congressional resistance. Local residents should understand that a bankruptcy judge’s role is limited in a Chapter 9 municipal bankruptcy case. Bond-holders are not accustomed to forced “haircuts” or having a “cram down” of principal or interest even under Chapter 9. Most of these cases involved purely consensual and voluntary readjustment of interests and some debt, but didn’t require judicial modification of bond-holder rights by force. There are very few reported cases of municipal bankruptcies in which the courts used the extraordinary power to modify principal.
Chapter 9 also limits the role of the bankruptcy judge in controlling expenses or a take-over of an insolvent municipality. When dealing with the rights of dissenting creditors, Congress established standards limiting the use of the “cram-down” powers: the court must determine in a Chapter 9 case if the readjustment plan of the municipality does not “discriminate unfairly”, protects the rights of dissenting creditors, and is “fair and equitable” to each not accepting class. Nonetheless, Chapter 9 is a forceful tool to help bring the parties voluntarily to the table, as seen recently in the Detroit bankruptcy case and the fundamentals of this chapter balancing between creditor and debtor rights, should be kept in mind as we come up with congressional or local solutions.
As Congressional staff ponder alternatives tailoring a two step hybrid type (voluntary negotiation and judicial mechanism) probably mirrored on the Chapter 9 framework and expanded to include not only municipals but also GO’s and other ELA obligations, the island appears stuck in political election year limbo. The question that remains is, how best to attack the mountain of debt that the local administrations have piled up? At the same time, there seems to be little interest in discussing the role of the various credit entities, the investment houses, banks and so called professionals involved in this credit market imbroglio. Nor does any government agency seem much interested in examining nor auditing what could turn out to be a series of excessive and improper extensions of Commonwealth government credit.
The recent historic example of the disgraceful financial mess and lack of prosecution in the U.S. savings and loan scandals, has obviously been lost. The magnitude and character of the Island’s “extra constitutional” debt was no secret. The same was well known to all key and sophisticated players in the Puerto Rico credit markets. Local and federal government regulators have been caught sleeping or looking away. The lack of current financial information, the continuing operating budget deficits and the faulty income estimates were easy to find. This all can’t be swept under the rug in such a cavalier fashion.
Hopefully, some one is interested in figuring out what really went wrong. The question is: why was this possession allowed to press the pedal and continue to accelerate down a wide open and unlimited market path, when the dangerous zone of insolvency was easily determinable?
* Former Chief judge of the U.S. Bankruptcy Court for the District of Puerto Rico and former member of the Bankruptcy Appellate Panel (BAP) for the First Circuit Court of Appeals, Boston, MA.
