STUMP » Articles » Puerto Rico Round-Up: Noticing the Disaster -- a Very Long Time in the Making » 8 April 2016, 12:03

Where Stu & MP spout off about everything.

Puerto Rico Round-Up: Noticing the Disaster -- a Very Long Time in the Making  


8 April 2016, 12:03

Before I get into it, just want to note one of the best places to get a grip of Puerto Rican finances is to check out the twitter feed of Cate Long. She obviously understands the Spanish language news stories she links to, and unfortunately, the auto-translated versions I would rather not post (because autotranslate has a hell of a long way to go. I get the gist, but most results look like word salad.)


Someone at Reuters did an in-depth piece on Puerto Rican pensions.

It’s rather long, so let me pull out just a couple remarks:

Since Puerto Rico gained self-rule in the late 1940s, improvident populist governments have lavished additional pension benefits on public employees, from holiday bonuses to loans for international travel. These measures have rarely been accompanied by moves to pay for them, and occasional efforts to fill the funding gap have fallen short.

Puerto Rican leaders have been eternal optimists, “always thinking things would eventually improve,” said del Castillo, 40 years old and now legal counsel to the Teachers Retirement System (TRS), one of two main public-employee pensions on the island. “But things continued to deteriorate, and deteriorate, and deteriorate.”

Today, TRS and the other main pension fund, the Employees Retirement System (ERS), together covering about 330,000 workers and retirees, are virtually penniless. Their combined unfunded liability totals $43.2 billion. With about $1.8 billion in assets to pay $45 billion in liabilities, the 96 percent combined shortfall is among the biggest of any U.S. state pension this century, and probably the biggest ever for pensions “of this size and scale,” said Keith Brainard, research director at the National Association of State Retirement Administrators.

And they’re only sinking further. Their combined burn rate – the difference between what they pay out and what they receive in contributions – is more than $1 billion a year, forcing them to rapidly liquidate assets. At that rate, they are forecast to run out of money in 2019, according to a 2015 report by actuarial and consulting firm Milliman, on whose recommendations the government relies.

Absent a permanent fix, the responsibility to cover benefits will shift to the Puerto Rican government, creating a pay-as-you-go system funded mostly by taxpayers. At $1 billion a year, retirement benefits would cost the island around 11 percent of annual revenue, an unsustainable burden when combined with the 36 percent of revenue now going toward paying bondholders.

The bondholders are already getting shafted. But even not paying bondholders will not stave off the reduction of the pension assets.


I want to remark on the “always thinking things would eventually improve” line — this is not unique to Puerto Rico. This is not even unique to governments.

But in all these cases, the bills do come due. Failure is always a possibility, the “government doesn’t go out of business” people to the contrary.

It does go out of business, and it most certainly does run out of money.

It starts out with not taking actuarially “required” contributions seriously.

“So what,” the people say, “The pension benefits are still being paid. We can always raise taxes if the pension funds run out.”

If that’s the case, why pre-fund the pensions at all? Think about it for a while. We can talk about fairness — intergenerational equity being the phrase often used. But fairness is a squishy concept. People change their idea of what is fair.

Let’s get to the nitty-gritty.


The concept is that the funding for pensions is part of the operational expense — it’s part of the total compensation of the employee at the time they did the service that earned the incremental pension benefit.

So far, so good. But that’s still conceptual.

What happens when you do not pay for the pension benefit at the point in time it is earned?

You make the likelihood that the pension will ultimately get paid to be much less, and not just in a mathematical sense.

Taxpayers can move away

This is what happened in Puerto Rico.

You can’t tax people or companies that aren’t there.

Who is going to pay?

The people who are left are the ones without options to leave —- exactly how much in taxes do you think those people can afford?

This happened in Detroit. This is happening in Chicago and Cook County generally. People leave. Connecticut may be seeing this, too.

Retirees don’t have much leverage

There are reasons retirees don’t have much leverage compared to active workers:

1. They can’t strike.
2. Often, they’ve moved to somewhere else.

Moving to somewhere else means that they can’t (legally) vote, and it also means that they’re not there for neighbors to see when their benefits get cut.

Sure, retirees can sue if their benefits get cut, but lawsuits don’t actually make money appear out of nowhere. You need to have some political oomph to be able to get your benefits.

If the pensions are fully funded, you don’t need to worry about the other items

What’s nice about having topped-up pension funds is that it doesn’t matter what the outside political climate is, those funds are there for the benefits and you don’t have to worry about it going elsewhere.

I am not a lawyer, but I do know it is much easier for lawsuits to bar governments from doing something (like siphon off pension money for non-pension purposes) than to make governments do something (like fully contributing to the plans.)

It is very difficult to get money out of a pension fund for non-legit purposes, without opening one’s self up to criminal liability.

Fully funded pensions are a safeguard for the retirees.

Taxpayers move away? That’s okay, your pension is paid for.
Moved away yourself? That’s okay, your pension is paid for.

Except, of course, in many places it’s not been paid for.

Here’s the contribution history for Puerto Rico:


So here is the state of play in Puerto Rico, as I can tell:

Puerto Rico just passed a bill allowing itself to not pay its bonds:

Puerto Rico Bonds Tumble on Debt Moratorium Bill
Bill allows U.S. commonwealth to stop making debt payments while awaiting help from Washington

Some Puerto Rico bond prices touched record lows after Gov. Alejandro García Padilla signed a bill that would allow the commonwealth to suspend debt payments while awaiting help from Washington in dealing with the island’s financial crisis.

The bill empowers Mr. García Padilla to impose a moratorium on payments to keep government cash flowing for essential services. It is the latest attempt by the U.S. commonwealth to protect money it says it needs for police and firefighters while it waits on action from the U.S. Congress or Supreme Court.

Under the provisions of the bill, the governor could evaluate whether to pay debt on an “entity-by-entity basis.” The moratorium powers would generally last through Jan. 31 with a possible two-month extension. The debt would remain outstanding, and missed payments would be due when the moratorium ends.

Some Puerto Rico general obligation bonds maturing in 2035 traded at 62.98 cents on the dollar Wednesday, below a previous low of 64 cents in June 2015, according to the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access website.

This is why it’s dangerous lending money to governments. They make the rules.

I guess the upside is that unlike medieval European monarchs, they won’t kill the creditors (or just eject them from the country for centuries) on top of not paying them.

Not that bond insurers are happy with this:

Assured Guaranty Ltd. is seeking financial information from Puerto Rico, and is looking to Washington for help.

The bond insurer, which guarantees repayment on about $3.8 billion of commonwealth securities, sent a letter Wednesday addressed to Cleary Gottlieb Steen & Hamilton LLP, which is representing Puerto Rico in its attempt to restructure $70 billion of debt, detailing multiple requests for information. The letter signed by Bruce Stern, Assured’s executive officer, was also sent to U.S. Treasury Secretary Jacob J. Lew, House Speaker Paul Ryan and other federal lawmakers working on legislation to address the island’s fiscal crisis.

Assured says that it has failed to receive complete financial information that it is entitled to as insurer of commonwealth securities after repeated appeals during the last 18 months, beginning with a request for Puerto Rico Highways & Transportation Authority maintenance agreements in September 2014. Assured is also seeking current balances for accounts that repay Highways debt and Puerto Rico Convention Center District Authority bonds after the two agencies began using reserve funds to make their Jan. 1 debt-service payments. Assured needs the data to plan for possible draws on its insurance policies, Stern wrote in the letter.

Everybody is hoping that the Feds will come to the rescue:

As Puerto Rico faces upcoming deadlines for paying bondholders and other creditors, all eyes are turning to Washington with hopes that the White House, Congress or even the Supreme Court can work out a solution.
There are many moving parts, including 20 classes of creditors holding as much as $72 billion in bonds and expecting $2 billion in debt payments in May and June.

With no resources to tap, the commonwealth has resorted to extreme measures, including borrowing from a nearly depleted pension fund, to pay bills and bondholders.

Remember what I said about “not taking money from the pension fund”? Ooopsie. I guess they can.

In any case, I wouldn’t look to Congress (or anybody) for a bailout. I doubt there’s any appetite for that. Especially if such a bailout is going to hedge funds …though a bunch of retail mutual funds will also get hit. Mutual funds favored by retirees due to their tax advantages.


Did you know there’s a Puerto Rico-related Supreme Court case?

You Can Lead a Horse to Water, But You Can’t Call it an Airplane: Supreme Court Oral Arguments Suggest Puerto Rico’s Recovery Act May Recover

Thursday, March 24, 2016
A few thoughts on Tuesday’s oral arguments before the U.S. Supreme Court in the litigation over whether Puerto Rico’s Public Corporations Debt Enforcement and Recovery Act, an insolvency statute for certain of its government instrumentalities, is void, as the lower federal courts held, under Section 903 of the U.S. Bankruptcy Code:

Due to Justice Scalia’s death and Justice Alito’s recusal, only 7 Justices heard the case and only 4 votes are needed for a majority. Almost all of the questioning at oral argument came from Justices Sotomayor, Kagan and Breyer, plus a couple noteworthy questions from Justice Ginsburg. With the standard disclaimer that questions at oral argument are not necessarily predictive of a Justice’s votes, it seems clear from the questioning that Justice Sotomayor will vote to reinstate the Recovery Act and is the most passionate of the Justices about the issue, and, even if the relatively silent Chief Justice Roberts and the silent Justice Kennedy and Justice Thomas vote to affirm, the questions and musings of Justices Kagan, Breyer and Ginsburg suggest that Justice Sotomayor could sway them to her position and thereby obtain the 4 votes necessary for reversal of the First Circuit’s holding and reinstatement of the legislation.

The First Circuit was persuaded that it would make no sense for Congress to act affirmatively to withhold from Puerto Rico the right to authorize its insolvent instrumentalities to file for bankruptcy under Chapter 9, while intending that Puerto Rico have the right to authorize such filings under some insolvency statute of its own creation. That seems almost unassailably correct; basic common sense suggests that whatever distrust of Puerto Rico must have motivated Congress to close the door to Puerto Rico’s ability to authorize its instrumentalities to file under Chapter 9 cannot be reconciled with Congressional intent that Puerto Rico be allowed to authorize such filings under its own version of an insolvency statute that might be identical to, or differ in unpredictable ways from, Chapter 9.
Puerto Rico’s persistence in seeking reinstatement of the Recovery Act reflects a calculus that an insolvency process that produces a legally questionable and potentially unenforceable result is better than no process, and provides creditors more incentive for consensual resolutions than no process. Chapter 9 eligibility for Puerto Rico’s instrumentalities, and, if Congress were to grant it, “super Chapter 9“ eligibility for Puerto Rico itself, would clearly, in Puerto Rico’s view, constitute a far more advantageous and conclusive process. However, there is some risk to Puerto Rico that if the Supreme Court reinstates the Recovery Act before Congress acts on federal legislation to address Puerto Rico’s financial woes, the revival of the Recovery Act would undercut any Chapter 9 momentum, leaving Puerto Rico with its legally wobbly Recovery Act. But Puerto Rico appears willing to gamble that the Supreme Court will issue its decision after Congress has done whatever it will do, and, in any event, to believe that a constitutionally vulnerable local bankruptcy statute in the hand is worth a constitutionally bulletproof federal bankruptcy statute in the bush.

More about the case:

Sotomayor Helps Puerto Rico Argue Its Bankruptcy Case

Before Tuesday, I’d have said that Puerto Rico had no chance to win its legal fight to let its municipalities and utilities declare bankruptcy. That’s how the island hopes to resolve its overwhelming debt problems, but the federal bankruptcy code says that it can’t.

That’s what the U.S. Court of Appeals for the First Circuit held last summer, unanimously. The statute seemed so clear that even Judge Juan Torruella, the appellate court’s only Puerto Rican member, concurred in an outraged separate opinion criticizing the federal law.

Then Sonia Sotomayor stepped in. Oral arguments before the Supreme Court rarely change the outcome of a case, yet Tuesday’s session may turn out to be the exception. In a fascinating and unusual argument, Justice Sotomayor, who is herself of Puerto Rican descent, spoke by my count an astonishing 45 times. Sotomayor left no doubt that she was speaking as an advocate.

The interpretation of the law she favored would make the system fairer to Puerto Rico, allowing the commonwealth to create its own emergency bankruptcy measures outside federal law. But it depends on a highly doubtful reading of the statute, one that stretches credulity when read into the text. Ideally, Congress will hear what happened at the oral argument and pass one of the reform proposals it’s currently considering that would spare the court from having to decide the case.

Technically, not all of the Constitution applies to Puerto Rico, and Landau declined to say that Puerto Rico would be barred from a default that abrogated the utility’s contractual obligations in its debt contracts. In practice, however, there’s little doubt that the contracts clause of the Constitution would indeed apply to Puerto Rico. Ginsburg knows that perfectly well.

That’s important. She almost certainly asked her question to signal that allowing Puerto Rico to engage in some sort of emergency default wouldn’t actually sink the creditors’ real-world claims. This is as close as Ginsburg gets to hinting that she might be prepared to hold for the commonwealth.

The silent participant in this entire unusual argument is Congress, which is considering legislation that would give Puerto Rico some way to restructure its utilities’ debts. The liberal justices are telling Congress that if it doesn’t help Puerto Rico bail itself out, they may do it themselves.

All this legal wrangling aside, it doesn’t change the bottomline facts of a decreasing taxbase and increasing cashflow obligations.

And the PR Development Bank is not in good shape:

Puerto Rico’s Government Development Bank, which was set up after the Great Depression to chart a course out of poverty, is on the verge of a collapse that would deepen the Caribbean island’s $70 billion debt crisis.

The lender was designed to promote business investment with a long-term horizon, but in recent years politicians turned it into a piggy-bank that lent to the government and its agencies, helping keep them afloat as the island’s economy shrunk. Now it’s rapidly running out of cash and poised to default on a $422 million debt payment due in May — raising the risk that it may be pushed into receivership or broken up.
The bank’s failure would undermine one of the last sources of cash that Puerto Rican authorities are counting on to pay teachers, firefighters and other employees, in a territory where almost half the population lives in poverty. Hedge funds are also laying claim to the money, filing a lawsuit against the lender this week, while in Washington lawmakers are mulling steps to put the island government under federal oversight and give it legal powers to restructure its debt.

This is getting a bit depressing. I wish I had happier things to blog about.

Anyway, don’t think it’s only Puerto Rico. This can also happen in Illinois or any other state — the states can’t use bankruptcy court, either. Only municipalities.

So I guess the happy thought is that Chicago can declare bankruptcy. If Illinois allows it to. Whee.

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