Bailout prevention

The clock is about to strike midnight for Puerto Rico. With payments of $422 million in debt due in May and $2 billion in July, Puerto Rico has run out of ways to postpone its looming default (see “Puerto Rico panic,” Dec. 26, 2015).

Chaired by Rep. Rob Bishop, R-Utah, the House Natural Resources Committee in April released its long-awaited plan for pulling Puerto Rico out of its $72 billion slough of despond. The plan calls for a seven-person federal oversight board that would take control of Puerto Rico’s finances, together with a debt restructuring law similar to the municipal bankruptcy provisions Detroit and other cities have used (and from which Puerto Rico has been excluded since 1984).

Rather than waiting for the Natural Resources Committee to finish its work, Puerto Rico enacted a “moratorium” law that purports to give Gov. Alejandro García Padilla the right to halt payments on any obligations Puerto Rico does not want to honor. The U.S. territory seems to be signaling that unless Congress passes the Bishop bill or something similar, it will pick and choose which creditors to pay, or perhaps stop paying everyone.

The result would be a complete mess. The pressure for a bailout as Puerto Rico’s economy collapsed would be irresistible. Even if Congress refused to bail out Puerto Rico, the Obama administration would find cash somewhere in the government’s coffers to funnel to the island. The Clinton administration did precisely that when Mexico was in financial distress in the 1990s, using a rainy day fund controlled by the U.S. Treasury Department to contribute to a $50 billion bailout.

This is why I find myself shaking my head when bondholders of Puerto Rican debt claim the Bishop bill’s proposed restructuring framework is itself a “bailout.” They seem to suggest that anything enabling Puerto Rico to pay less than all of its debt must be a bailout. But that’s not what most of us think of as a bailout. What ordinary people call a bailout is using taxpayer money to rescue a troubled business or entity.

Restructuring actually would make a real bailout far less likely. If Puerto Rico’s debt were restructured, there would be less need for Washington to flood Puerto Rico with taxpayer funds.

Critics also warn that if Congress allows Puerto Rico to restructure its debt, Congress would feel compelled to let states file for bankruptcy too. I personally don’t think this would be such a bad thing. If Congress doesn’t pass a bankruptcy framework for states, it is hard to imagine how Illinois is going to deal with its enormous (more than $100 billion) underfunded pension problem.

But there’s no reason to think that a restructuring plan for Puerto Rico would quickly lead to a bankruptcy law for the states. Puerto Rico is very different from a state. Congress has almost complete control over the island, thanks to the Territorial Clause in Article IV of the U.S. Constitution. Congress’ authority over the states and their finances is more limited, due to the constitutional protections for state sovereignty.

Critics do have one legitimate complaint, however: Reducing Puerto Rico’s debt won’t do much good unless Congress also fixes the territory’s political system. Giving a federal control board the power to veto bad budgets and reform Puerto Rico’s dysfunctional bureaucracy, as the Bishop bill currently proposes, might do the trick. Puerto Rican lawmakers have denounced the board as “colonialism” and insist they must be left in charge. If Congress gives in, and provides debt relief without government reform, Puerto Rico will simply start spending and running up debt all over again.

It’s not clear that even a strong federal control board and a restructuring framework would solve Puerto Rico’s problems. But it’s the only strategy I’ve seen that might work.