The Perverse Incentives of Puerto Rico’s Debt Deal
Puerto Rico’s Financial Oversight and Management Board, created under the administration of former President Barack Obama, recently reached an agreement with the Commonwealth’s government to restructure the island’s debt, which has been in default since 2017. Media outlets have speculated about a possible “end to the largest bankruptcy proceeding in U.S. history.” The only remaining obstacle is the approval of Chief United States District Judge Laura Taylor Swain of the U.S. District Court for the Southern District of New York, who is in charge of the proceedings according to the 2016 PROMESA law (the Puerto Rico Oversight, Management, and Economic Stability Act).
The deal only reached Swain’s desk, however, after the federal oversight board agreed to Puerto Rico Gov. Pedro Pierluisi’s demands “of zero cuts to pensions of current retirees and current accrued benefits of active public employees,” plus funding of $500 million per year for the University of Puerto Rico until 2027.
As John Dizzard of the Financial Times wrote, the holders of Puerto Rico’s defaulted bonds “are being handed deep haircuts on their face value whilst pensions for retired public sector employees are left intact.” As bondholders lose out to pensioners, politicians are turning the logic of secured credit investing on its head.
One of the hearings for Puerto Rico’s defaulted debt concerned $3 billion “in bonds backed by Puerto Rico highway tolls and excise taxes,” and $800 million “in debt secured by taxes on rum paid to Puerto Rico by the federal government,” notes Courthouse News Service‘s Thomas F. Harrison. After the default, Harrison adds, “the insurers for the bondholders tried to collect from the trust funds” to which the revenues were supposed to be paid, only to find “that the (Puerto Rican) government had been diverting the money away.”
One reason why the federal oversight board is legitimizing such conduct is the precedent from the 2008-2009 bailouts and bankruptcy proceedings of Detroit carmakers. Some of the same decision-makers of the financial crash era have also been involved in the Puerto Rican debt dealings.
In 2016, Obama named former judge Arthur J. Gonzalez to the federal oversight board for Puerto Rico. In 2009, Gonzalez was in charge of the Chrysler bankruptcy proceeding. As George Mason University law professor Todd Zywicki wrote of that “egregious” process: “Creditors who held the company’s secured bonds were steamrolled into accepting 29 cents on the dollar for their loans. Meanwhile, the underfunded pension plans of the United Auto Workers—unsecured creditors, bu
Article from Reason.com