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David Skeel explains why Puerto Rico needs access to bankruptcy

January 19, 2016

Penn Law’s David Skeel discusses the financial crisis and Puerto Rico and the island’s need for access to bankruptcy.

Puerto Rico is in the midst of a major financial crisis. The governor has said that the territory’s current debt of over $70 billion is unpayable, but the island has no access to bankruptcy. Penn Law sat down with David Skeel, S. Samuel Arsht Professor of Corporate Law and an expert on bankruptcy and corporate law, to discuss the current situation and what’s next for Puerto Rico.

Penn Law: Could you give us a rundown of what’s going on in Puerto Rico and where we’re at, as of this moment?

David Skeel: Puerto Rico has been in severe financial crisis for a while. They’ve been hemorrhaging population. It’s seemed clear, for at least the last year or two, that Puerto Rico is not capable of paying its obligations.

It seems clear that Puerto Rico can’t muddle its way through. The Commonwealth is probably going to have to restructure its debt, in addition to whatever else is done to help it out.

Puerto Rico’s governor and congressional representative have been pushing for access to bankruptcy, at least for its municipalities, maybe for Puerto Rico itself. It doesn’t have either now because Puerto Rico’s municipalities were excluded from Chapter 9, the municipal bankruptcy provisions of the bankruptcy laws, in 1984. There has been discussion about some sort of federal funding — some kind of bailout. There’s also been discussion about other legislative changes such as relaxing the minimum wage requirement, which many economists on both sides of the aisle think is too high for Puerto Rico.

PL: Who are Puerto Rico’s creditors?

DS: The main creditors are bond holders. Puerto Rico has issued a large amount of debt. Its municipalities — including its electricity company, its water company, and a number of other entities — have also issued significant amounts of bonds. Its overall debt is in the neighborhood of $72–73 billion dollars.

PL: And who are these bond holders?

DS: They’re a variety of different investors. They’re mutual funds, in many cases. To some extent, they’re Puerto Ricans. Hedge funds own a significant amount of the debt as well. A large percentage are institutional holders.

A lot of Americans, as well as Puerto Ricans, have an interest in Puerto Rico’s debt, mostly through mutual funds. If you’ve invested in a mutual fund — particularly if it’s a municipal or high yield debt fund — you may have Puerto Rico debt.

Another major creditor is pension beneficiaries. Puerto Rico’s public pensions are underfunded by an estimated $40 billion. That’s another big piece of the picture.

PL: What do you argue would be the best way forward, given that Puerto Rico has all this debt, yet also has obligations to its citizenry?

DS: In my view, the most plausible — almost the only plausible — strategy starts with some kind of control board to oversee Puerto Rico’s finances, as was done with New York City back in the 1970s. It’s been done with Washington, D.C. and other cities since then. In addition, I think Congress needs to give Puerto Rico’s municipalities, at least — and probably Puerto Rico itself — access to bankruptcy.

PL: So you think bankruptcy should be an option?

DS: Absolutely it should be an option. I think if bankruptcy isn’t made available, it’s going to be a mess. It’s already turning into a mess now. Several bond funds have sued because of defaults, so there’s already litigation against Puerto Rico. There’s really no clear process for deciding who gets what if there’s no bankruptcy option. 

PL: What are the arguments for the parties that are against bankruptcy, and what are the arguments for the groups who think it’s absolutely essential?

DS: It’s easier to make the argument for advocates of bankruptcy such as Puerto Rico’s governor and congressional representative. To put it simply: there’s not enough money to go around. To continue paying all of the bond holders, many of whom are hedge funds, Puerto Rico would have to cut services more than they already have, and the island would be increasingly unlivable. And the worse things get on the island, the more people leave. At some point, it is simply inhumane to continue cutting services.

The argument from the bond holders’ perspective is that Puerto Rico owes them the money and should find a way to repay it. Until recently, many bond holders insisted that Puerto Rico was capable of paying all of its debts if the Commonwealth got its fiscal house in order — although most don’t say this so much anymore. Bond holders have also argued that it’s in Puerto Rico’s best interest to keep paying, because if Puerto Rico doesn’t pay their investors, they’re not going to be able to borrow money in the future, when they really need it. The way bond holders often try to pitch it is: it’s good for you and for us if you keep paying us.

One of the striking things to me about the Puerto Rico situation is that both the New York Times and the Wall Street Journal have now come out in favor of giving Puerto Rico access to bankruptcy.  There’s still considerable opposition, but I think it’s at least possible bankruptcy advocates will prevail.

PL: Do you see a breaking point with this crisis in the near term? What do you think is actually going to happen?

DS: To some extent, we’ve hit the breaking point. Puerto Rico has a billion dollars in debt that’s due or about to come due, and they’re already picking and choosing which obligations to pay. There is another wave of debt coming due in a few months — it could be that’s the real breaking point, if there aren’t major adjustments between now and then.

As far as what’s going to get done, it’s really hard to tell. I’ve been very surprised by the politics. I would have thought that many Republicans would be in favor of bankruptcy for Puerto Rico.

That’s not been the case. Democrats generally support bankruptcy for Puerto Rico; most Republicans are opposed. But there does seem to be some softening of that opposition. There have at least been some signals that there is a real interest in working out some kind of a deal. My guess is, if it were to happen, it would probably have to be a package.

That package might be bankruptcy plus a control board that Congress has some control over, plus maybe relief from the minimum wage, which Republicans would be sympathetic to. Some Democratically leaning economists are also sympathetic to minimum wage relief for Puerto Rico, even though many of them believe we should have a higher minimum wage on the mainland.

Would I predict it’s going to go through? I’m not predicting anything; it’s such a fraught political environment. But at this particular moment, it looks like there is widespread interest in doing something. I’m not as pessimistic as I might have been a couple months ago.