The Cautionary Tale of Puerto Rico’s Fiscal Crisis and PROMESA’s Broken Promises

 

I rise today to discuss the significance of the unprecedented events now occurring in Puerto Rico. According to a May 16th editorial in the Wall Street Journal, “the legal brawl over Puerto Rico’s bankruptcy begins this week, and it will be long and ugly.” As we’ve seen in Greece and Detroit, what’s happening in Puerto Rico should be a wake-up call for fiscally distressed states, cities, and territories to get their own houses in order. At the same time, it should be a cautionary tale for those who seek to extend similar bankruptcy authority to the states.

 

In 2015, after years of fiscal mismanagement and borrowing to finance operations, Puerto Rico declared that its debt was unpayable and had to be restructured. However, because Puerto Rico lacked access to chapter 9 of the bankruptcy code, restructuring its complex debt outside of court presented a challenge.

 

I held a hearing in the Judiciary Committee to examine this issue in December 2015. We learned that while bankruptcy is an effective tool to restructure debt, it merely treats the symptom and not the disease. I shared the view of many others that unless Puerto Rico addressed its fiscal mismanagement woes, extending bankruptcy authority alone couldn’t fix the problem. Instead, it would merely kick the can down the road and harm thousands of retirees in Iowa and elsewhere, who would bear the costs of Puerto Rico’s irresponsible behavior.

 

The Obama Administration, though, pressed Congress to act and provide Puerto Rico with an orderly, bankruptcy-like process to restructure its debt. According to the testimony of one Treasury official, “without a comprehensive restructuring framework, Puerto Rico will continue to default on its debt, and litigation will intensify. . . As the cascading defaults and litigation unfold, there is real risk of another lost decade, this one more damaging than the last.”

 

Ultimately, this debt restructuring framework was coupled with an independent oversight board and adopted as the Puerto Rico Oversight, Management, and Economic Stability Act, referred to as PROMESA. This approach, we were told, would tackle Puerto Rico’s debt crisis in an orderly way and help to remedy the years of fiscal mismanagement.

 

Nevertheless, I remained concerned that PROMESA and its bankruptcy-like provisions would invite years of litigation and uncertainty, due to the lack of existing court precedent. So it’s no surprise that a recent Bloomberg article entitled “Puerto Rico’s Bankruptcy Fight is About to Plunge into the Unknown,” described the bankruptcy process as a “circular firing squad” with “no established rule book to shape what comes next.”

 

The article reports that one market analyst “foresees a chaotic brew of lawsuits” because “nobody has any idea what’s going to happen.” And according to one news report, this is just the beginning, as PROMESA’s bankruptcy provisions are “more likely to face years of appeals than a typical case.” Despite assurances otherwise, what happens next, in the months and years to follow, may be far-reaching and likely impact us all.

 

In particular, prior to the enactment of PROMESA, Puerto Rico, like the states, couldn’t declare bankruptcy. As I predicted last year, granting Puerto Rico the authority to restructure all of its debt, including its state-like constitutional obligations, would be viewed as precedent for giving states similar authority. Well, I’m not surprised to see that this is now occurring. This past September, William Isaac, the former head of the FDIC, called on Congress to pass a law “giv[ing] Illinois the option of utilizing chapter 9, which is akin to what Congress just did for the Commonwealth of Puerto Rico.”

 

The New York Times reported on May 3rd that “bankruptcy lawyers and public finance experts are watching Puerto Rico’s case closely, to see if it shows a path that financially distressed states like Illinois might also one day take.” And the Chicago Tribune’s editorial board recently wrote that investors are growing nervous about the talk of states seeking a bankruptcy system after the fashion of Puerto Rico, calling Puerto Rico “the frightening ghost of Illinois future.”

 

The editorial wondered how much more difficult it would be for states to borrow money, if lenders knew the states could shirk their obligations in bankruptcy when the debt comes due. Those who dismissed concerns that PROMESA would set a troubling and dangerous precedent should take notice and make sure that a one-time piece of legislation does not create a new norm.

 

I hold out hope that PROMESA might manage to provide some help for Puerto Rico. Success, though, will ultimately require strong leadership from the Commonwealth’s leaders, which for years has been lacking. There’s a lesson to be learned here. The fiscal crisis in Puerto Rico should motivate states, cities, and territories to find the courage now to make tough choices—which are the foundation of responsible governance—rather than look to the federal government and bankruptcy as a way out. If they do not, the effects could be long-lasting, harming the vulnerable both within their populations and outside their borders.

 

Obviously, what a lot of smart people told us a year ago would solve Puerto Rico’s problems hasn’t worked out. At a time when states, citizens, and markets are all watching, we must stress fiscal responsibility and pay attention to what’s happening in Puerto Rico. Otherwise, the uncertainty and chaos we were assured wouldn’t come to pass may be just over the horizon.

 

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