STUMP » Articles » Puerto Rico: Dawning Reality Update... and a touch of Chicago » 20 January 2016, 05:57

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Puerto Rico: Dawning Reality Update... and a touch of Chicago  


20 January 2016, 05:57

It’s been a few weeks since Puerto Rico did the hokey-pokey with some of its debt, defaulting yet again.

Let’s see what they’re up to now:

SAN JUAN, P.R. — Four months after announcing a grueling five-year plan for reducing the island’s vast debt and reviving economic growth, Puerto Rico’s top economic officials said on Monday that they had been too optimistic and revised the plan for the worse.

When the government first released its five-year plan last September, it warned creditors that it would need $14 billion of debt relief over that period, because it did not have enough money to pay them the total amount due, $28 billion.

In a briefing for journalists on Monday, officials said they now expected to need a $16 billion break from creditors.

The officials said they had run updated forecasts for 10 years as well, and things did not get much better. Over the full 10 years, they said, they would need $24 billion worth of reductions in the total $63 billion in principal and interest that various branches of government owed creditors.

With inadequate revenue and no ability to borrow, Puerto Rico’s cash has been drying up. The island was able to make a number of large, high-priority debt payments due on Jan. 1 only by taking money away from lower-ranking creditors. The island’s next significant debt payment, of $400 million, is due in May from the Government Development Bank.

The development bank is important because it orchestrates most of Puerto Rico’s complex web of debt, and because it has the increasingly difficult job of making sure all branches of government have adequate cash. There are concerns that if it ran into severe problems, they would spread to other parts of the government.

And on July 1, so many debt payments are due that the officials said that without relief, there would be defaults from the top to the bottom of the hierarchy of creditors. When questioned further, they said it was still too soon to reveal how much relief they would seek from each creditor group.
Mr. Lew and other Obama administration officials have been urging Congress to enact measures they say would help it restructure its $72 billion of debt in an orderly manner. In particular, the administration has argued that Puerto Rico needs access to a legal framework, like bankruptcy, that would automatically stay creditor lawsuits and make it possible to force dissident creditors to accept settlements. As currently written, the bankruptcy code bars Puerto Rico’s cities or other bodies of government from using Chapter 9, the provision that insolvent cities and counties on the mainland have been able to use to shed debt.

Some have access to that route, that is. Places like Chicago need permission from their states to access Chapter 9.


Let’s look at the reaction to the possibility of bankruptcy:

Bankruptcy policies that U.S. lawmakers are considering for Puerto Rico could have a chilling effect on the broader municipal bond market, according to a major investor in the commonwealth.

“If you grant [Puerto Rico] unique protections, or unique ability to restructure its debt not afforded to the states, that sets an insidious beginning for undermining confidence in the willing to pay across the municipal marketplace,” said Hector Negroni, the co-CEO and CIO of New York-based Fundamental Credit Opportunities.

Despite indications to the contrary, senior Puerto Rico officials of the commonwealth are not actively negotiating with many creditor groups, he added.

Granting Puerto Rico what has been referred to as “Super Chapter 9” — lumping all 18 bond issues together under the same terms — could lead to fiscally struggling U.S. states trying to pursue a similar extraordinary restructuring option for their own outstanding debts, said Negroni, who holds bonds issued by Puerto Rico and is the former head of municipal trading at Goldman Sachs.

I don’t the specific details of anything being put together in Congress (and given that body often has to pass bills to find out what are in them, I doubt many in Congress know the details as well), but I understand that if bondholders are treated differently not in line with seniority and credit protections written into specific bond issues, there really would be a serious muni problem.

That said, what Puerto Rico did in trying to write bond rules into their constitution… that seems questionable to me.

Reaching back to December 2013

Not long after Padilla took office in January [2013], Wall Street debt rating agencies downgraded the island’s bonds to just one rung above junk status. Like states, the commonwealth of Puerto Rico cannot file for bankruptcy. Also, Puerto Rico’s constitution offers bondholders strong guarantees that they would be paid before pensioners and public workers if the government went broke.

That provision was called into question last year:

Late on Friday [6 February 2015] a U.S. federal judge ruled that the U.S. commonwealth’s so-called Recovery Act, which made some of Puerto Rico’s agencies eligible for court-supervised debt restructuring, violated the U.S. constitution by allowing a state government to modify municipal debt.

Another thing that was declared unconstitutional: teacher pension reform (April 2014).

There’s just so many unconstitutional things going on all over the place!

It would be nice if there were a process in place in which all the obligations could be handled at once, rather than in piecemeal fashion in which nothing lasting will be resolved.

Everybody knows that Puerto Rico does not have the ability to pay its debt, whether short term or long term.

The island has even less money than everyone thought, according to the latest figures out Monday, and it’s having to resort to “extraordinary measures” to pay its bills.

The cash crunch is so bad that Puerto Rico’s prison system is no longer paying the vendor that supplies food for inmates, and some special education instructors have stopped getting paid, according to a senior government official. The island is also delaying people’s tax refunds.

Over the next decade, Puerto Rico must close a nearly $24 billion funding hole, worse than previously projected in September. That’s after raising taxes and severely cutting expenses.

The island’s problems center on how to deal with just over $70 billion in total debt.

“A significant restructuring of the Commonwealth’s debt is inevitable,” the government report concluded.

Restructuring = defaulting on some of the debt. That’s just baked in. The question is how it’s going to get done.


Puerto Rico is not going to avoid pain, whether there’s a Super 9 bankruptcy, “regular” Chapter 9 bankruptcy adapted so that PR can use it, or the de facto bankruptcy mess it’s going through right now.

But why not a bit of responsibility on the bondholders part?

Here’s a different take on fiscal responsibility:

Burry was interviewed by New York Magazine about his response to the response to the crisis and his answers are revealing. While the book and the movie wrap a complicated story into an entertaining package that basically blames the financial Armageddon of 2007 on bad, greedy bankers, Burry’s view speaks to basic, essential human virtues.

When asked if anything positive came after the crash, Burry says no. “The biggest hope I had was that we would enter a new era of personal responsibility. Instead, we doubled down on blaming others, and this is long-term tragic,” Burry says. And he’s right. Blaming others is not only terrible public policy because it doesn’t accomplish anything or repair any problem, but also because it poisons the culture and how we relate to one another as fellow citizens.

Burry offers a good summation of why the blame game is a rotten apple. “If a lender offers me free money, he argues, “I do not have to take it. And if I take it, I better understand all the terms, because there is no such thing as free money.” His analysis continues,

“[It] is just basic personal responsibility and common sense. The enablers for this crisis were varied, and it starts not with the bank but with decisions by individuals to borrow to finance a better life, and that is one very loaded decision. … Whether it’s the one percent or hedge funds or Wall Street, I do not think society is well served by failing to encourage every last American to look within. This crisis truly took a village, and most of the villagers themselves are not without some personal responsibility for the circumstances in which they found themselves. We should be teaching our kids to be better citizens through personal responsibility, not by the example of blame.”

This also holds on the other side. Those holding muni bonds should not be throwing money at governmental players that are unlikely to pay them back. They have the responsibility to do due diligence. And when you are buying low-rated debt, even if it’s governmental (especially if it’s governmental, I’d argue), you need to realize that the chances you won’t get paid back is pretty high.

Sometimes the responsibility is foisted upon the bond insurers (maybe those bonds shouldn’t have been insured, eh?), but the point is that when you shove money into something, you need to take responsibility for making that decision.

With the liar loans/CDO^2/etc., some of the banks took a bath, but some got bailed out. Some of the individual “homeowners” who took out the liar loans or overborrowed without lying got some mini-bailouts.

Don’t be expecting more bailouts.


According to this, some meetings involving Treasury Secretary Jack Lew are happening today:

Lew is scheduled to meet on Wednesday with officials and community leaders to talk about the proposal that President Barack Obama’s administration presented Congress to create a territorial bankruptcy regime that would allow Puerto Rico’s government to restructure its debt and impose new oversight on finances and expand Medicaid benefits, among other things.

Puerto Rico does not have access to any local or federal bankruptcy laws. Meanwhile, the U.S. Supreme Court recently announced it would hear an appeal on a ruling that barred Puerto Rico from giving municipalities the power to declare bankruptcy.

Ryan spokeswoman AshLee Strong said the speaker has ordered the House committees of jurisdiction to work with the Puerto Rican government, review options, and report back by the end of the first quarter. Ryan has pledged the House will come up this year with “a responsible solution” for Puerto Rico’s debt problems. Meanwhile, Garcia praised Lew’s letter.

“We thank Secretary Lew for reminding Congressional leaders that they can still prevent this humanitarian crisis from spinning out of control,” he said.

Republican leaders including Sen. Orrin Hatch, R-Utah, have demanded to see audited financial statements from Puerto Rico, but they have not materialized. Jesus Manuel Ortiz, public affairs secretary for the Puerto Rican government, said Friday that the statements are nearly ready and would be produced soon, although he didn’t specify a date.

Interesting Orrin Hatch is mentioned. He put forth something ostensibly about Puerto Rico that would have interesting effects well beyond PR:

The Tougher U.S. Pension Rules in Puerto Rico’s Rescue Plan
The proposed changes would mark unprecedented federal authority over state and local pensions and make their financial status look a lot worse.

Congress might choose to extend unprecedented federal authority over state and local pensions. An effort to impose new reporting requirements, if approved, would ultimately cast the financial status of state and local pensions in a much more dire light.

The proposed requirements were included as part of a financial assistance bill introduced last month to address Puerto Rico’s debt crisis, but they would also apply to states and localities throughout the United States.

The legislation, sponsored by Orrin Hatch, a Utah Republican who chairs the Senate Finance Committee, would make state and local pension plans file annual reports with the U.S. Treasury Department. The new filings would have to include an alternative valuation detailing how well-funded the plan is. In nearly every case, that would mean a lower valuation.

State and local government groups, including the National Conference of State Legislatures and the National Association of State Retirement Administrators (NASRA), quickly voiced their opposition to the idea. They sent a letter to Congress, along with 15 other groups, complaining that the proposed provision targets all pensions, rather than limiting the issue to Puerto Rico, and that extra filing at the federal level would be too time-consuming and costly.
The biggest potential change centers on each pension plan’s discount rate — that is, the rate of return on investments that’s used to determine its overall fiscal health. The higher the expected rate of return, the lower the amount of funding a government needs to pay into its pension plan. The opposite, of course, is true when the rate of return is lower. The Senate bill would require plans to use an assumed rate of return pegged to a Treasury rate (these days, around 3 to 4 percent), instead of the 7 to 8 percent rate most plans now use. That change would have a drastic effect on how financially healthy a plan looks.

Should be interesting to see how that shakes out. I assume that particular valuation issue will not get passed.


Okay, maybe not everybody, but it will be interesting to see how fast the idea spreads among deeply insolvent systems.

Chicago Public Schools might get their own legal bankruptcy:

“Chicago Tonight” has learned that Gov. Bruce Rauner and top Republican leaders are planning to introduce legislation aimed at an emergency financial takeover of the city of Chicago and Chicago Public Schools. This comes in light of an imminent $500 million shortfall within the Chicago Public Schools system.

The Republican leaders are set to announce the legislation tomorrow, but Paris Schutz has the exclusive information tonight.

Sources tell “Chicago Tonight” that the governor and his top two legislative leaders – Senate minority leader Christine Radogno and House minority leader Jim Durkin will file a package of legislation Wednesday that would allow for an emergency financial oversight board appointed by the state to take over the financially strapped school district. Other legislation would allow for emergency financial oversight of the credit-beleaguered city of Chicago.

Legislation would also allow for CPS and the city of Chicago to declare bankruptcy – something by law both cannot currently do.

We will definitely be hearing more about that.

Both Puerto Rico and Chicago Public Schools’ insolvency problems are no longer just a long-term issue, but are in a short-term meltdown.

To quote Hemingway:

“How did you go bankrupt?”
Two ways. Gradually, then suddenly.”

― Ernest Hemingway, The Sun Also Rises

Don’t let people tell you that the 2008 stock market drop is to blame for these insolvencies. These hideous debt situations took decades to build up.

The danger has been known for years, and it’s just now that things are unwinding.

And without a bankruptcy process in which all debt can be restructured – which includes unfunded pension liabilities – the debt will fester for decades, even after de facto defaults.

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