On October 14, the outgoing Governor of Puerto Rico, Alejandro Garcia Padilla, who is not running for re-election next month, addressed the Oversight Board which is charged by Congress with addressing the disastrous finances of the insolvent government of Puerto Rico. In default on more than a billion dollars of its debt, with no prospects of repaying its debt in full, having run deficits for 15 straight years, and trapped in the U.S. dollar currency zone, the government has massively difficult problems ahead. So do its creditors and the Oversight Board.

Creation of the Oversight Board was a necessary step. Now its work has really begun. The Governor presented to it the government’s draft fiscal plan for the next ten years-the opening gambit in what will unavoidably be complex and tense negotiations. The substance and the rhetoric of the presentation are instructive.

Garcia Padilla conceded that the accumulated debt and economic problems “are the culmination of decades of misguided and unscrupulous public policies in San Juan,” a fair admission, but immediately adds that these unscrupulous public policies were also in “Wall Street and Washington.” Surely somebody else is also to blame.

“Puerto Rican children and retirees are not to blame for careless decisions made here in New York by the rating agencies”-so it’s the bond rating agencies’ fault-“or the mistaken decisions made by Congress,” such as ending tax subsidies to Puerto Rico. Of course, there are the “greedy lenders” who bought Puerto Rico’s bonds.

The insolvent debtor, the Puerto Rican government, does make his list of the culpable, but only previous administrations. “Puerto Rican families and workers should not be bound by the irresponsibility of prior governments.” This is a remarkable proposition in political theory: that the actions of a government in the past are not binding on the present.

Garcia Padilla offers reforms in government behavior: “We must create more disciplined financial decision making with improved budgetary controls and financial transparency.” “We must rationalize expenditures and tax policies that promote efficiency. Agencies with overlapping functions should be consolidated.” “Tax enforcement and administration should be improved to…reduce evasion.” These are indeed needed reforms, but one should ask why they haven’t been done already. They are required no matter what else happens, and it is among the responsibilities of the Oversight Board to make sure they are implemented.

Should government spending be reduced? “You [the Oversight Board] will soon realize that any reduction in spending…will further throw Puerto Rico into a death spiral.” Extravagant language. It is true that when, like Greece and Puerto Rico, you cannot depreciate your exchange rate to address your uncompetitive costs, and you wish to avoid a steep internal deflation, your choices are more difficult.

“You [the Oversight Board] will soon agree that Puerto Rico requires…a meaningful partnership with the federal government.” This means the “partner” needs to send money. “Our plan shows that, even if Puerto Rico and its creditors were to do their part, we need the assistance of the federal government to bring this economic and humanitarian crisis to an end.” In shorter form, we need a bailout. How the bailout relates to the creditors is not defined. The Governor repeats: “We and the federal government must be partners.”

Moreover, “We also have to safeguard Puerto Ricans’ savings by ensuring the stability of the local credit union system.” These institutions have huge losses from none other than buying the debt of the Puerto Rican government, so now they need a bailout, too. They do not participate in federal deposit insurance.

And we must “provide adequate funding for our public pension plans.” At present these plans are almost entirely unfunded to the tune of about $44 billion. How unfunded pension obligations relate in seniority to the claims of bondholders in municipal insolvencies is hotly contentious. Garcia Padilla’s address seems to assume that the pensions are simply senior.

As for the bonds, “We must adjust our debts to sustainable levels.” Without doubt, that is true. But how much adjustment is that? Well, “The message should be clear: without a change in federal policy and without a change in trajectory of the island’s economy toward real growth, there will be no money for any debt service at all.” (my italics) Quite a shot across the bow.

In the details of the “Commonwealth of Puerto Rico Fiscal Plan,” simultaneously published, page 10 has relevant projections. These might be taken to imply that if all goes well, including help from U.S. taxpayers, the average recovery of the bondholders could be in the vicinity 55% of the scheduled debt service over the next ten years. However, “The Plan does not provide a specific debt restructuring proposal.” And “The Commonwealth believes that creditors should share in both the benefits and the risks of economic growth projections.”

In sum, the Oversight Board has been formed and discussions with the government of Puerto Rico have started. The Puerto Rican financial drama has a long way yet to run.

 

Alex J. Pollock is a distinguished senior fellow at the R Street Institute in Washington, D.C. He was President and CEO of the Federal Home Loan Bank of Chicago from 1991-2004.