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Helping Puerto Rico in both the short and long term

by Benjamin Zycher, opinion contributor - 10/17/17 4:40 PM ET

Given the severe fiscal pressures facing Puerto Rico — about $72 billion in debt — and the destruction wrought by Hurricane Maria, it is absolutely appropriate that substantial federal aid be defined and delivered by policymakers in Washington.

Accordingly, on Oct. 12, the House passed a bill including a federal loan of $4.9 billion for Puerto Rico as part of $36.5 billion in hurricane and wildfire relief for several states. The Senate is expected to pass the bill this week.

At the same time, policymaking is political, and the temptation to use legislation and its implementation to transfer wealth is powerful. Aid can be structured in different ways, and the longer-term effects of alternative loan provisions in particular are likely to yield very different impacts in the context of the future creditworthiness of the commonwealth and the incentives for crucial policy reforms.

Witness the recent argument from President Trump that the massive debts owed by the commonwealth will have to be “wipe[d] out.”

The president does not have the authority to effect that sort of outcome, but it is possible that the legislation eventually emerging from Congress might subordinate existing debts to the forthcoming federal loan; or the procedural implementation of the loan by federal agencies might have that effect as a practical matter.

Those threats have been directed at Wall Street, but the reality is that the creditors include retirement funds invested in Puerto Rico bonds, including tens of thousands of investors living on the island.

Subordination would be an enormous mistake imposing substantial adverse effects upon the commonwealth itself over the longer term. Consider the Puerto Rico Electric Power Authority (PREPA), the bonded debt of which is about $9 billion.

If the legislation eventually to be enacted subordinates Puerto Rico’s existing bondholders, that outcome would not be very different from the treatment of the General Motors and Chrysler creditors in 2009, when the Chrysler secured creditors were coerced into accepting not only far less than their legitimate claims, but fewer cents on the dollar than the GM secured creditors and the pension plans of the United Auto Workers, unsecured but vastly more favored politically.

Such subordination would be perverse in several dimensions. First, it would ignore the recent history of concessions made by the PREPA creditors, who reached a restructuring agreement with two different administrations of the Puerto Rico government.

That agreement provided debt relief of $1.7 billion over the first five years and at least $2 billion in the first 10 years. That deal was three years in the making, but in the end was scuttled by commonwealth officials.

As the devastation from Maria unfolded, the creditors offered a $1-billion loan in exchange for some assurance that a portion of the debt would be paid, an offer angrily rejected by the Puerto Rico government even as the electric grid remained inoperative for almost the entire island.

Incentives for future creditors to make concessions during periods of fiscal stringency are unlikely to be strengthened by preemptive assaults on their positions.

Even before Maria, PREPA faced very large needs for capital investment for new generating plants, improved transmission and distribution networks and tightened environmental requirements. Those investment needs will require access to capital markets on terms that are affordable for future PREPA ratepayers

But that longer-term goal is inconsistent with the recent demands for ever-greater concessions from the PREPA creditors, and now with the “kiss that money goodbye” rhetoric emanating from the White House and elsewhere.

Because congressional action was required to overcome political constraints in the commonwealth, a compromise in 2016 between Congress and the Obama administration — the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) — created an oversight board with debt-restructuring powers and a formal legal process to deal with emerging disputes between the creditors and commonwealth debtors.

Subordination of existing debts would shunt these procedural safeguards aside, with future effects in terms of market expectations and incentives that cannot be salutary.

No one denies that PREPA has been mismanaged for many years. Accounts receivables practices are widely acknowledged to be dismal. PREPA gives vast amounts of power to local government agencies essentially at no charge, yielding enormous waste and upward pressure on rates for the remaining ratepayers.

Incentives to correct such practices will not be strengthened if debt service becomes easier, rather than harder to avoid, and an implementation of a subordination provision would do precisely that.

That mismanagement seems to have afflicted the PREPA response to Maria as well. Department of Energy Situation Reports on six previous hurricanes (Harvey, Irene, Irma, Katrina, Matthew and Sandy), as well as other data, show that the average number of days needed to restore power to 90 percent of customers was 10 days.

For PREPA after Maria, about 5 percent of customers were restored after 10 days, and only 10 percent of customers after 15 days. Governor Ricardo A. Rosselló recently expressed an “expectation” for 25 percent within a month.

Perhaps conditions on the island fundamentally are more adverse than in the other afflicted regions. To the extent that that is true, it is unclear why PREPA chose not to accept aid from the American Public Power Association, the normal process for such emergencies.

Instead, PREPA hired a little-known outside contractor with limited relevant experience to restore the power lines. Whatever the realities on the ground, subordination of existing Puerto Rico debts would reduce the willingness of the capital market to invest in modernization, for PREPA and for the commonwealth more generally.