In 2016, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which created the Puerto Rico Financial Oversight and Management Board to restructure the Commonwealth’s unsustainable burden of more than $72 billion in debt and more than $55 billion in unfunded pension liabilities. The board oversaw a bankruptcy process that culminated in March 2022, when a federal court confirmed a plan that reduced Puerto Rico’s debt by 80%. Still, the work of putting the Commonwealth on a sustainable fiscal path remains incomplete. At our annual Municipal Finance Conference in July 2022, four experts weighed in on the effects of PROMESA and the challenges that remain: Natalie Jaresko, former executive director of the oversight board; Sergio Marxuach, policy director at the Center for a New Economy; David Skeel, chairman of the oversight board and professor of corporate law at the University of Pennsylvania Carey Law School; and John Ceffalio, senior research analyst for Municipals at CreditSights. The panel was moderated by Michelle Kaske of Bloomberg.
You can watch a video of the panel here. Here are a few highlights.
Was PROMESA successful in achieving its goals?
Yes, the panelists agreed. “It did take a long time, but it really did work overall in my view,” said David Skeel. “Our objective when we started was… once and done…. Puerto Rico can’t do this multiple times…. And that meant we were very, very careful about how much debt there would be going forward.” Under the plan crafted by the Financial Oversight and Management Board, the maximum amount Puerto Rico can borrow in any year is $1.15 billion, a sum equaling about 8 percent of the Commonwealth’s own revenues excluding federal aid. He described the plan as “clearly sustainable for Puerto Rico going forward” and “clearly fair to the creditors,” particularly the general obligation bondholders.
Sergio Marxuach cautioned, however, that while the debt limits were a temporary success, they will eventually expire, and the Commonwealth’s budgeting process still needs reform. “I do think there’s a need to legislate new Puerto Rico safeguards in terms of fiscal rules, limits on deficit spending, and debt issuance. We already have some of those… in our constitution, and they obviously did not work or at least they were relatively easy to work around,” he said. Natalie Jaresko emphasized that the debt restructuring was a necessary but not sufficient condition for Puerto Rico’s economic success. “Now you need political will on the part of the elected leadership to do what elected leaders need to do,” she said.
What about the Puerto Rico Electric Power Authority (PREPA)?
PREPA, Puerto Rico’s primary electricity supplier, has long been a source of frustration for Puerto Ricans. Its troubles predate the island’s financial crisis. Electricity was unreliable and expensive, and Hurricane Maria further damaged the utility’s aging infrastructure. Its finances remain unresolved. Skeel said that the government of Puerto Rico and the oversight board have been working towards increasing system reliability by bringing in private operators. PREPA is also in negotiations for debt restructuring. Jaresko noted that critical FEMA funding has been slow to arrive and that many of its benefits are yet to be realized. In addition, legacy generation assets are being gradually decommissioned with a “cleaner, cheaper, and more reliable generation on the side of renewables” phasing in, she said.
When will the oversight board be disbanded?
According to PROMESA, the oversight board will be terminated once Puerto Rico has access to credit at reasonable rates and has achieved four consecutive years of balanced budgets. John Ceffalio noted that the wording of this section is vague: “When you read it, it’s ‘adequate access to short-term and long-term credit markets at reasonable interest rates.’ What does ‘adequate’ mean? What are reasonable interest rates?”
Jaresko and Skeel agreed with Ceffalio’s assessment but noted that the law is purposefully written to allow the oversight board flexibility in determining the criteria for its own termination. Both Skeel and Jaresko believe the 2022 fiscal year (which ended June 30, 2022) could turn out to be the first year for which audited statements show Puerto Rico has balanced its budget.
What additional steps or safeguards are needed to improve Puerto Rico’s fiscal position?
Puerto Rican bonds are not currently rated by any of the major credit rating agencies, making it difficult for the Commonwealth to borrow on public markets. For the bonds to gain wider traction on markets, Ceffalio said, Puerto Rico needs audited financial statements: “I don’t know if that’s enough to get the rating, but I think that would be a big step.” Jaresko and Skeel underscored this point, arguing that audited financial statements are needed to show definitively that the government’s budget is balanced.
While enabling future borrowing is important, Marxuach cautioned against enabling the excessive debt that led to the crisis:
“[T]he language in the constitution says that whenever… expenses exceed available resources… then Puerto Rico… must increase taxes. The thing is that the phrase “available resources” has been interpreted by different lawyers and even by the Puerto Rico Secretary of Justice, Attorney General, to include the issuance of debt. So, that’s how we got into this mess… [in]… the first place… because the concept of available resources is much broader than available revenues. And they include the issuance of new debt for deficit financing in order to bridge the gap. So, that’s one of the things that we definitely need to fix in the constitution.”
Resolving other problems could also improve the island’s economic health. By increasing PREPA’s reliability, uncertainty may be reduced in the eyes of rating agencies, Ceffalio stated. “Having reliable, affordable energy affects all economic activity,” and is essential for economic growth, Marxuach said.
What lessons does Puerto Rico offer other governments and the municipal bond market?
One of the lessons from the Puerto Rico restructuring is the novel use of a Contingent Value Instrument that links bondholder payouts to sales tax revenues. Bondholders, in essence, will do better if Puerto Rico’s economy does better. “Sales tax revenues, as revenues go, are pretty precisely determined. It’s pretty hard to play games with them,” Ceffalio said. “They… track the economy really well.” He and Skeel agreed that this instrument could be used in future municipal bankruptcies.
The panel also discussed whether Puerto Rico had established a precedent of pensioners taking smaller haircuts than bondholders in municipal bankruptcies. Jaresko argued that the Puerto Rican pension system was structured differently than pension systems in other prominent municipal bankruptcies, such as Detroit. Also, Puerto Rico pensions had been cut before PROMESA. As such, she thought Puerto Rico’s situation was “somewhat unique.” Ceffalio, however, said that “there is a precedent that was set in Detroit and in some of the California bankruptcies” that “in negotiations… the pensioners I think have a better moral claim and better political claim… than does a mutual fund, who might be hesitant to get into a public fight with pensioners. So, I do think that’s largely a precedent and it’ll continue to go that way.”