Puerto Rico is in deep trouble. The island is currently struggling under $73 billion in outstanding debt, with no feasible way of meeting its obligations. The economy is struggling, resulting both in low tax revenues and a further strain on welfare spending. If nothing is done, default looks to be just around the corner, an outcome that would be catastrophic for Puerto Rico’s future.
Many have proposed a variety of solutions, from bailouts, to bankruptcy, to imposing a fiscal control board to manage the island’s finances, but no action has been taken yet. The question we should all be asking is: why not?
For good little taxpayers, voters, and citizens, it is natural to assume that when government sets out to solve a problem its decisions are made primarily on the basis of impartial analysis of what is best for all affected parties. The idea of the noble, public-spirited bureaucrat, despite centuries of experience to the contrary, remains stubbornly lodged in the American mind. It would be kind of sweet if it weren’t so infuriatingly contrary to the way so much happens in the real world.
Puerto Rico is an excellent example of this: As the island negotiates how to resolve its crippling debt crisis, advisors on all sides are attempting to represent their own points of view as objectively optimal solutions. Not so. In fact, few people involved in the Puerto Rico debt debate have a purely selfless interest in coming up with a neat and timely solution to the crisis.
Kept Promises Help the Entire United States
For example, general obligation bondholders, naturally, want a solution that makes them whole, since the island’s constitution explicitly promises the primacy of their repayments. This position has drawn some criticism, as the bondholders are perceived as only looking out for themselves.
This is undoubtedly true, of course, but the story they tell Congress—to which I am sympathetic—is that investment and economic growth simply cannot resume on the island as long as general obligation bonds trade at 50 cents on the dollar, since reneging on a guarantee that explicit will deter future borrowing and invalidate any future promises made to investors.
A solution that protects the general obligation bondholders, their argument continues, not only benefits them but also is good for municipal bond investors elsewhere. A resolution that protects their investments will lead investors to put more faith in the implicit promises contained in the general obligation bonds of various states that have some degree of long-term financial problems, such as California and Illinois. Therefore, a promise kept in Puerto Rico leads to lower borrowing rates for the states.
If we’re going to discount bondholders’ arguments because of their self-interest, it’s worth asking whether conflicts of interest exist for other participants in this negotiation as well. For instance, what is in the best interest of Antonio Weiss, the U.S. Treasury’s point man for Puerto Rico? While he avers that he just wants what’s best for the island’s citizens, he is also a former senior banker for Lazard, and it’s a reasonable assumption he may return to his former employer when his term ends at the end of the year.
Banking Cronies Oppose Bondholders
Lazard is an investment bank that specializes in advising governments that face a financial crisis of some sort, and one of their clients is the Puerto Rican government. A few months ago Weiss hired another former Lazard employee, Stephen Campbell, to advise him on the Puerto Rico matter.
Given that Treasury’s current position—which is that Congress set aside the provision in the Puerto Rican constitution protecting general obligation debt—happens to coincide perfectly with Lazard’s advice, we ought to acknowledge Treasury’s connection to the company. Such a precedent would potentially wreak havoc on other states with precarious finances, such as Illinois. If bondholders see a possibility that their bonds won’t be honored and laws protecting their interests may be ignored, this could hasten financial crises elsewhere—and potentially generate new business for Lazard, some have suggested.
But Weiss is not the only potentially compromised adviser: Cleary Gottlieb and Millstein and Co., two other advisers to the island’s government, have little incentive to reach an expedient end to the current crisis, since that would shorten the number of months they are able to collect consulting fees from Puerto Rico. Cleary has been working on the island’s dime for nearly two years already and received $25 million in 2015 alone. It has also been on the payroll for Argentina for the last 15 years of that country’s restructuring, so a decade-long sovereign debt morass is something they’ve benefited from before.
Richard Ravitch, another adviser to Puerto Rico, is even more compromised. As a board member for the bond insurer BAM, which happens to be one of the major three insurers without exposure to Puerto Rico, his firm would profit handsomely should the bondholders take a big hit on their investments. A haircut of the size the island’s advisers are advocating could potentially bankrupt the insurers, giving BAM a monopoly.
Politicians Want to Hide This Until After the Election
It is fair to point out that the Republican-led Congress has its own set of incentives heading into the November elections. Having to go on record voting for anything perceived as a bailout could hurt anyone facing a primary from a Tea Party candidate, so leadership has an incentive to delay at least until the primaries are over. While extending Chapter 9 bankruptcy protection in its current form is nothing remotely like a bailout, a determined opponent could obfuscate the issue enough to prosecute that brief in an election.
If Democrats see the possibility of being able to use a fiscal collapse against the Republican Congress come November, then they could easily adopt the position that whatever Republicans propose is insufficient and deny them the votes needed to pass any legislative assistance.
The point is that there are many winners and losers in any potential restructuring of Puerto Rico, and it’s important to understand who’s advising whom and what their incentives are. Not everyone benefits from a quick and tidy fix to Puerto Rico’s ills.
A country’s creditworthiness makes all the difference in the world. Making the general obligation debt constitutionally sacrosanct helped Puerto Rico attract capital at rock-bottom interest rates the last few decades. Argentina’s recent resolution of its debt morass under its new president may be the match that lights a fire of foreign direct investment into the country. The new government has already talked to the CEOs of Coca Cola, Facebook, Google, Mitsubishi and various energy companies about investing in the country.
All the key players in the Puerto Rico debate are, to a greater or lesser degree, looking out for number one, but a solution that restores economic confidence and the ability of the island to become financially solvent should carry a good deal more weight than either concerns for the balance sheets of mega-consulting firms or the politics of the upcoming elections.