Treasury's Weiss outlines Administration proposal at Natural Resources Panel; GOP members skeptical of allowing island to access bankruptcy, debt restructuring

The House Financial Services Oversight and Investigations Subcommittee on, February 25, held a hearing on "Puerto Rico's Debt Crisis and Its Impact on the Bond Markets." The island territory faces a total of $72 billion in debt to 18 different issuers, and its government defaulted on $174 million in payments due in January. House Speaker Paul Ryan (R-WI) has given lawmakers until the end of March to develop a solution for the crisis, which some observers have speculated could be attached to the FAA authorization bill.

In a separate hearing at the House Natural Resources Committee, Treasury Department counselor Antonio Weiss also testified on the Puerto Rico debt crisis. Weiss outlined a new plan proposed by Treasury that would place pension payments to retirees ahead of payments to bondholders. He said this move was driven by signs that the island's pension system is nearly out of money. "The major problem is, the entire pension system is close to being depleted, but 330,000 people depend on it," Weiss said. "It's unfunded, and they have to be protected." Shielding retirees would also encourage younger retirees to stay there, rather than move to the mainland, he said. Weiss said Treasury also supports a plan to temporarily suspend litigation to prevent a shutdown of basic government services on the island and give time for voluntary negotiations with debt holders. The Treasury plan also would create a voting mechanism to prevent a handful of officials from blocking a reasonable compromise. If debt negotiations fail, a court-supervised structure would ensure what Weiss called an "orderly resolution."

Weiss pressed Congress to act to address the crisis, saying that in the absence of a restructuring regime, Puerto Rico will default and lawsuits will multiply. "As the cascading defaults and litigation unfold, there is real risk of another lost decade, this one more damaging than the last," he said. During Q&A, Weiss said that Treasury's proposal did not envision the sort of Chapter 9 bankruptcy that U.S. states can use for their agencies, but a new law "customized to the unique conditions that face Puerto Rico." Weiss said the PR legislature would need to be convinced of the need for an oversight board because it "doesn't fully understand what this oversight authority would consist of ... . There is no room for error in this economy," Weiss said. "The government remains open only because the governor authorized more than $1 billion in onerous and unsustainable emergency liquidity actions." He also called upon Congress to allow for the restructuring of the island's Medicaid program to prevent Affordable Care Act funds from becoming exhausted as early as June 2017.

At the House Financial Services hearing (testimony is posted here), the witnesses were:

— Dr. Anne Krueger, Senior Research Professor of International Economics, John Hopkins University School of Advanced International Studies

— Juan Carlos Batlle, Senior Managing Director, CPG Island Servicing, LLC

— William M. Isaac, Senior Managing Director, Global Head of Financial Institutions, FTI Consulting

— Dr. Mark Zandi, Chief Economist, Moody's Analytics

In his opening statement, subcommittee Chairman Sean Duffy (R-WI) noted that Puerto Rico is one of the largest issuers of municipal bonds because if its triple tax exemption. Duffy said that while some predict a debt crisis for the territory in the future, he believes it "may already be here." Ranking Member Al Green (D-TX) said that allowing the territory to access Chapter 9 bankruptcy protection will not be enough, and PR's debt must be restructured to offer it more autonomy.

Among the witness statements, Anne Krueger, a professor at the Johns Hopkins School for Advanced International Studies, said she was hired by Puerto Rico's Government Development Bank in January 2015 to lead a study of the island's economic situation and prospects. She said there were numerous factors that had contributed to the island's economic decline, including the fact that the U.S. federal government in 1996 began to phase out the tax-exempt status it had granted mainland companies that operated on the island, which had allowed the pharmaceutical industry to become a "leading industry" there. Some companies then left, and the government borrowed money to cover budget deficits. But as debt accumulated, debt service and borrowing costs rose, and efforts to impose controls were ineffective. Krueger said the poor state of statistical reporting in PR was another factor: "Books are not closed until well after the end of reporting periods," she said. PR remained economically stagnant even in times of global growth, she said, adding that the island was also hurt by its ineligibility for the Earned Income Tax Credit (EITC) and Chapter 9 bankruptcy protection, as well as the slow pace of approvals for various business permits. Its prospects are also clouded by large future pension liabilities. She said a legal framework for comprehensively restructuring its debt is "crucial."

Later, in questions with members, Krueger said, "I'm afraid that the situation is so dire that the question is not whether the bondholders will lose, but whether they will lose a little or lose a lot. Somehow or another, Puerto Rico can't make all those payments ... The very basic things of that government have to continue."

Juan Carlos Batlle, of CPG island Servicing LLC and a former president of Puerto Rico's Government Development Bank (GDB), said various economic plans for PR have failed "not because they were flawed or inadequate, but because we failed to execute, we failed to compromise," and the island also showed an inability and unwillingness to change and adapt. He also cited: 1) the lack of adequate, independent regulation over the GDB and the Economic Development Bank for Puerto Rico; 2) a fragmented ,government-wide technological structure that has not focused on "delivery" to the end user; and 3) a lack of accurate, independent and timely financial and economic data as well as trustworthy budgetary forecasts. Batlle said a federally mandated fiscal oversight and control board should be established alongside alongside a proven legal framework, "like Chapter 9, that provides for the reorganization of municipalities, utilities and instrumentalities of Puerto Rico, including restructuring of debt of non-Constitutional and insolvent issuers. He said this was the only way to safeguard and protect Puerto Rico and the $3.7 trillion municipal bond market, along with economic stimulus measures and a "debt restructuring mechanism that would promote consensual negotiations and agreements as pre-conditions to authorize eligible municipalities and instrumentalities to reorganize under Chapter 9."

William Isaac, a senior managing director at FTI Consulting, said any reform plan for Puerto Rico "that does not include fundamental structural reforms to government fiscal programs will doom the plan to ultimate failure." He said "substantial thought" should be given to the size and scope of services that should be provided by the Commonwealth government, and there should be a more effective tax collection system. Among his recommendations, Isaac said Congress should: 1) treat PR like any U.S. state by allowing the Commonwealth's municipalities access to Chapter 9 bankruptcy, and 2) create a federal control board to oversee the island's finances. Such a board should not have the ability to negotiate with creditors or restructure debt, but could be empowered to recommend normal Chapter 9 bankruptcy for specific instrumentalities of the Commonwealth after certain financial metrics have been met. Isaac said he was "very concerned by proposals coming from the Treasury Department" that would allow "Super Chapter 9 bankruptcy" or a "Super Control Board" that would restructure of all of Puerto Rico's debt, even its Constitutional debt. Granting that power to Puerto Rico, or to a "Super Control Board" created by Congress, "would be unprecedented and would have far-reaching implications, including raising the costs of borrowing for the fifty states."

Mark Zandi, chief economist at Moody's Analytics, said that Chairman Duffy's proposal, HR 4199, "is important in that it provides Chapter 9 bankruptcy protection to the island's municipalities and public corporations. This would allow for an orderly restructuring of approximately 30% of the island's outstanding debt," but the island would have to accept the establishment of a Financial Stability Council [FSC]. Zandi said Congress should consider shifting from Chapter 9 bankruptcy for the island's municipalities and public corporations to adopting a broader restructuring framework for all of the island's debts. "The [FSC] would be empowered to implement a temporary stay, say 12 to 18 months, of all debt payments, to use this time to fashion a sustainable restructuring." He said it "seems a stretch to argue that allowing Puerto Rico to restructure its debt will lead other states to demand the same authority." Zandi added that Congress should also "ensure that Puerto Rico is reimbursed for Medicaid at the same rate as governments on the mainland by ensuring that current federal funding under the Affordable Care Act is not scaled back beginning in 2018 as is currently legislated." Implementation of the EITC would also provide a meaningful boost to the economy, he said.

Questions

Chairman Duffy said he was concerned that restructuring PR's debt could set a dangerous precedent, raising costs elsewhere. Batlle told him that mechanisms that are "unfamiliar" to the municipal debt markets could create volatility and uncertainty.

Emanuel Cleaver (D-MO) also said that allowing the territory to access Chapter 9 bankruptcy protection could cause trepidation in the muni bond markets. But Zandi told him that all the witnesses agreed on the necessity of a debt restructuring, saying the only question was how broad the framework should be. Zandi told Carolyn Maloney (D-NY) that he favored a broad framework allowing PR to address all of its economic problems. But Isaac said that "nothing good will happen" if Puerto Rico is allowed to change its bankruptcy rules, though he said it was important to prevent the island's debts from becoming even worse.

Nydia Velázquez (D-NY), who was born in Puerto Rico, reflected the views of other Democrats when she said the territory should be allowed to declare bankruptcy on some of its debt, and she and warned against imposing tougher restrictions: "If the control board takes the people's power away, it will just be viewed as another colonial power grab by the government. What they need is not only bankruptcy protection, but economic growth."

Mick Mulvaney (R-SC) echoed Chairman Duffy in arguing that favoring pensioners at the expense of bondholders could set a bad precedent. "That doesn't strike me as fair ... I'm sympathetic to what the island is going through," he said, noting that he supports more fiscal controls on the island. "Those are all positive things that don't cost my folks any money. But everything else sounds to me like bailout."

Bruce Poliquin (R-ME) also voiced frustration with the island's government, saying, "Now you folks come to us, asking for what? Any solution has to include a governmental fix so this doesn't happen again. This is just not fair." Poliquin also questioned why taxes are not being collected in the territory.