EMTA SPECIAL SEMINAR: PUERTO RICO AT A CROSSROADS
Monday, September 28, 2015
360 Madison Avenue, 17th floor
(on 45th St. between Madison and 5th Aves.)
New York City
As the Commonwealth of Puerto Rico looks for ways to cope with its debt-payments difficulties by seeking debt relief and reforming its revenues, expenditures, and operations, there have been numerous discussions and proposals put forth by bankruptcy and economic experts on the best path forward for the island's government.
This panel will discuss the roots of Puerto Rico’s debt problem, reforms that could address these problems, and applicable historical models of change and opportunity established by other over-indebted national, state or local governments. The panel will also examine the proposals included in Governor Alejandro Garcia Padilla's recent Fiscal Adjustment Plan, their viability and constitutionality, and alternative or complementary policy measures that should be considered by the authorities in both San Juan and Washington.
11:45 a.m. Registration
12:00 noon – 2:00 p.m. Panel Discussion
Arturo Porzecanski (American University) - Moderator
Douglas Holtz-Eakin (American Action Forum)
Charles Blitzer (Blitzer Consulting)
Liam Localio (Greylock Capital Management)
John E. Mudd (Law Offices of John E. Mudd)
David Hitchcock (Standard & Poor's)
Lunch will be provided
Support provided by Standard & Poor's.
Seminar on Puerto Rico
This Special Seminar “Puerto Rico at a Crossroads” was supported by Standard & Poor’s and took place at EMTA’s offices in NYC on September 28, 2015. Arturo Porzecanski (American University) moderated the panel, with the following panelists: Douglas Holtz-Eakin (American Action Forum), Charles Blitzer (Blitzer Consulting), Liam Localio (Greylock Capital Management), John E. Mudd (Law Offices of John E. Mudd) and David Hitchcock (Standard & Poor’s). Relevant documents addressed during the panel discussion can be accessed by Clicking Here.
As the Commonwealth of Puerto Rico looks for ways to cope with its debt-payments difficulties by seeking debt relief and reforming its revenues, expenditures, and operations, there have been numerous discussions and proposals put forth by bankruptcy and economic experts on the best path forward for the island’s government.
The panel discussed the roots of Puerto Rico’s debt problem, reforms that could address these problems, and applicable historical models of change and opportunity established by other over-indebted national, state or local governments. The panel also examined the proposals included in Governor Alejandro Garcia Padilla’s recent Fiscal Adjustment Plan, their viability and constitutionality, and alternative or complementary policy measures that should be considered by the authorities in both San Juan and Washington.
Arturo Porzecanski opened the discussion by asking panelists what, in their opinion, are the top two reasons why the government of Puerto Rico finds itself in the current, dire financial circumstances, given that it’s facing bankruptcy, admitted it cannot make its current payments and has lost access to the capital markets in an environment of “high sky coupons”. As he so astutely states, “having a good diagnosis is important when discussing an appropriate course of therapy”.
Douglas Holtz-Eakin responded by pointing to the manufacturers’ tax breaks in 1996, the 2000 start of the budget deficit, the decline in real GDP compared to growth and a delayed recognition that the economic decline was, in fact, occurring. However, his top two reasons for Puerto Rico’s current position are the economy and high debt and minimum wage levels. John Mudd pointed to the Socialistic mindset of the government, where Capitalism was going to disappear, planned economies would be the norm and the government would be the “generator” for its constituents. Liam Localio spoke to the large deficits as a result of institutional deficiencies, the perennial problem of stopping funding for some services, the fact that the government is already tapped out with the capital markets (which limits their ability to rise above a crisis) and the lack of monetary policy because of the government’s association with the US. Charles Blitzer discussed the roots and difficulties (which are fiscal) and the “woefully outdated development model”. Porzecanski posited that the triple tax exempt status of Puerto Rico’s bonds was a major contributor to the problem, with the government being part of the problem, not the solution. Either the bondholders or the unions (or both) would have to make concessions to bring Puerto Rico back on track.
Porzecanski then asked, with regard to the government’s “Fiscal & Economic Growth Plan” disseminated in September, what some of the revenue, spending and reform proposals the panelists like or dislike the most, and why. Further, he questioned whether, in general, the degree and nature of fiscal effort and structural change envisioned is appropriate to the circumstances, and whether the projected financial gaps are under- or over-estimated. He also asked the panelists to assess the advisability and feasibility of the home-made Control Board with a higher level of authority that the government has proposed. And, finally, he asked for an assessment of the chances that these revenue, spending and reform proposals will actually be passed by the legislature in San Juan, their likely implementation in a timely manner, and about the relevant political realities on the ground.
Holtz-Eakin indicated that he was not a big fan of the Plan, which was heavily dependent on revenue and light on spending cuts. He felt that the government was just too big, and he was skeptical of the Control Board as a necessary step. In any event, the Control Board would need to be sufficiently independent. This encroachment on Puerto Rico’s sovereignty (ceding control to the US government is unlikely), coupled with the need for the US to “own” the problem (“owning” DC was different) through this Control Board, makes it unlikely, in his opinion, for the Plan to pass as currently drafted. Blitzer noted that fiscal adjustment to close modest-sized deficits similar to Puerto Rico’s (about 1-1.5% of GDP) has frequently occurred in Latin America, and that IMF studies indicate that the confidence-building effects of closing a fiscal gap typically outweigh any associated fiscal drag, resulting in a net positive impact on growth. Given the collapse of private investment by Puerto Rican residents and the associated capital flight, the key to restore growth is to restore confidence, in part through fiscal adjustment and in part through adopting pro-growth structural change policies. As he succinctly put it, “gimmicks [like a weak Control Board lacking real power] never create credibility”. Localio’s view of the Plan was negative for bondholders because they wouldn’t be paid at par, but, looking at the Plan as impartially as possible, he questioned what the government was willing to pay and what the bottom line would be for cash flows and principal and interest payments. Without a meaningful dialogue with creditors, it is difficult to assess whether the deficits are smaller or greater than they need to be. He strongly recommended a significant engagement with all creditors moving forward. David Hitchcock forecasted that it would be difficult to implement the Control Board and that, with differing creditors having varying interests, litigation was inevitable, with a restructuring on a global basis nearly impossible. While the teachers’ pension system changes were ruled invalid, it would not be problematic to consolidate schools with a declining population. Mudd deemed the Plan “garbage” and posited that, if Puerto Rico doesn’t grow, it won’t be able to pay its debts. Even the modest proposed changes in labor law may not be approved, and it is highly unlikely that the US Congress will seek to take this project on, given the myriad of other US issues facing it in the near term. Also, the Puerto Rican constitution requires a republican form of government and that can’t be amended; the government can’t delegate its powers to the US government. Therefore, the Control Board is “dead on arrival” and, if it passes, will be of dubious constitutionality.
Porzecanski responded to his own series of questions on the Plan by providing some background. He compared the current lack of transparency and accountability in the Puerto Rican government to the Emerging Markets period in the ‘60s. The business model has to change, especially if one considers that the government and its instrumentalities won’t have access to reasonable commercial lending terms. While every crisis has the ability to be solved, he does not believe that the government will use this crisis as an opportunity to make better choices in the future. Running the utilities as a joint venture with private participation or a concession format may be worthwhile to consider and is short of full privatization. The US Senate is conducting a hearing on Puerto Rico on September 29, so there may be some movement on this topic since it has been a long time since the US got involved in any way with Puerto Rico.
Porzecanski’s next series of questions related to the advisability and feasibility of the various measures that the Plan envisages Washington ought to take in order to aid Puerto Rico. He questioned whether there was political room for a “Grand Bargain” in the making, and whether the US leadership has “gone AWOL” with “benign neglect” since, in other cases, it is not unusual for the Administration/Executive Branch to provide Congress with some course of action.
Holtz-Eakin responded with the minimum wage and alternate Medicare and Medicaid programs, but due to the Jones Act and other considerations he thinks it unlikely that the US will do much of anything. Neither the President or Treasury care much about this topic, and they don’t want to discuss any bail-out proposals as their domestic priorities would be compromised if they so engage. Blitzer’s view is that outsiders shouldn’t get involved in dealing with Puerto Rico’s debt until Puerto Rico has demonstrated its ability and readiness to make some fundamental changes on its own. Mudd reminded the audience that the Jones Act also applies to Hawaii and Alaska, and that there was a big difference in what goods and services were provided to Puerto Rico and other places, like the Virgin Islands. He wondered whether a “Super Chapter 9” requested by Puerto Rico would ever be implemented, but, in any case, Chapter 9 “does not relieve all problems”. Localio thought that Congress could act, but it would not be willing to do so.
Porzecanski’s final questions were the following: Do you envision a selective or generalized default in the months ahead, as the government’s liquidity dries up? How do you feel about the government’s stand that all debts, no matter their seniority, should be on the table for renegotiation purposes? What is your view of the magnitude of needed or likely debt relief, or of bond recovery values?
Hitchcock’s view is that it was already in a selective default scenario with the public financing corporate default, but that S&P expects a global default as the government seeks a global solution and is willing to endure many years of litigation. Mudd agreed that it was already in default, with a larger default looming. Localio reviewed the numbers and forecasted a default in the GDP payment in December and other coupon payment in January, which will put the government in a weaker position on any restructuring proposal it suggests. Blitzer posited that there was a high probability that this would be the “first default of choice in recent memory on a massive scale”. Reviewing the numbers, this looked like a massive liquidity (not sustainability) problem with a massive loss of creditor confidence as the government keeps insisting that debt restructuring is the only way forward. The government should be able to refinance itself – if it commits to a monitorable program to balance its budget over the next 18 months -– but it doesn’t want to. It has refused to work with investors who have indicated a willingness to consider providing necessary bridge financing. The least successful sovereign bond restructurings had a 75% acceptance rate, but this will not be the case here since other countries had much larger amounts of debt relative to their GDPs and fiscal models clearly showing the sustainability problems going well beyond liquidity. With no modern documents, bond contracts that are simply resolutions, no CACs and an inability to walk away from judgments, Puerto Rico had little chance of accomplishing a successful debt restructuring without massive litigation. (Mudd also explained that the civil law jurisdiction pertained to Puerto Rico and that parts of the Civil Code had not been interpreted by any court.) Blitzer concluded that a broad restructuring/default is not the only alternative, and there are disastrous costs and consequences to Puerto Rico, its economy and its citizens of going along the path the governor and his team have set out (namely, big pressure on banks, greater capital flight and more migration).