Fixing Puerto Rico

The fight over fixing Puerto Rico

Is the territory the next D.C., or the next Greece?

By Danny Vinik

Is Washington about to take over Puerto Rico?

The territory’s dire financial crisis took a step toward resolution last week when the House Natural Resources Committee released a draft plan to give the federal government an extraordinary new power: a five-member oversight board that could enact laws and regulations over the objections of Puerto Rico’s own elected officials.

Though such boards are used at times by states to rescue a troubled city, it’s an unusual move for Washington, and the financial firms that hold Puerto Rican bonds are spooked: the proposed board would also have authority to allow the island to restructure its $72 billion debt, which could cost the bondholders significant money.

In defense of the plan, supporters point to a successful example from two decades ago. In 1995, Congress imposed a control board on Washington, D.C., after it faced a budget crisis of its own. It took a few years to get the city back on its feet, but today the move is widely considered a success.

“It’s a great analogy,” said former Rep. Tom Davis (R-Va.) who chaired the House subcommittee with jurisdiction over D.C. until 2000. He added, “The city’s a miracle when you go back 20 years and look at what it was.”

But critics say that this analogy misses the mark, and that Puerto Rico and D.C. are different enough that the Puerto Rico move would be genuinely unprecedented—and risks undermining political support for the difficult policy decisions the island must make to reverse its economic crisis.

“It’s easy to say that you should go in and tell them what to do and they can do it,” said Simon Johnson, the former chief economist at the IMF who is now a senior fellow at the Peterson Institute for International Economics. “It’s very, very hard to make that work in a place that has a strong sense of independence.”

In 1995, the District of Columbia faced a $722 million deficit on a $3.2 billion budget. It was bordering on insolvency and desperate for financial help from the federal government. Instead, the feds took control. The District of Columbia Financial Responsibility and Management Assistance Act allowed then-President Bill Clinton to appoint a five-member financial control board that would have wide authority over the District’s budget and the ability to overrule then-mayor Marion Barry, who called the move a “rape of democracy” and “bloodless coup.” The board would exist until D.C. balanced its budget four years in a row.

The D.C. control board quickly made a number of reforms to close the budget deficit. It reduced the city’s workforce by thousands, reformed the city’s relationship with the federal government to reduce the financial burden on the District and implemented stronger financial management controls. By the 1998 fiscal year, the deficit was gone and it stayed that way for the next three years. On September 30, 2001, the board suspended its activities. Even Barry was impressed with the results, telling the Washington Post in 2011, “It was able to do some things that needed to be done that, politically, I would not do, would not do, would not do.”

The comparison between D.C. and Puerto Rico, in one sense, seems reasonable. Both are part of the United States, but overseen directly by Congress rather than within the structure of a normal state. They both lack representation on Capitol Hill.

But, critics argue, that’s where the similarities end. It makes a certain sense for Congress to impose a tight rein on D.C.: Many D.C. residents work within the federal government or interact with it on a daily basis and Congress already retains control over certain powers of government, including the ability to overturn any D.C. law.

Not so Puerto Rico. Washington, D.C. is more than 1,500 miles from Puerto Rico’s capital, San Juan, and Puerto Rico’s population is more than five times as large. Asking Congress to take control of an area so far away invites civil unrest as unelected officials parachute in and impose harmful policies to solve the economic crisis. “D.C. was much more intertwined with the federal government [than Puerto Rico is],” Johnson said. They also are treated differently under the law. For instance, D.C. residents are eligible for the Earned Income Tax Credit. Puerto Ricans are not.

In a sense, Washington operates like a normal American city whose state governor happens to be Congress. But Puerto Rico is not like either a city or a state. It has many of the same responsibilities as a state, but lacks any representation in Congress.

And while D.C.’s crisis was mostly limited to negative annual operating balances, Puerto Rico’s is more like a sovereign debt crisis, said Alice Rivlin, who was the chair of the D.C. control board from 1998 to 2001 and is now a senior fellow at the Brookings Institution. Puerto Rico’s debt has risen to $72 billion, equal to nearly 70 percent of the island’s GDP, a far higher debt-to-GDP ratio than any other state. Already, Puerto Rico has defaulted on minor amounts of the debt. But unlike states, the island’s municipalities cannot declare bankruptcy through Chapter 9 of the bankruptcy code, leaving it with little leverage to negotiate a voluntary restructuring of its debt with its creditors.

To those creditors, the draft financial plan is major threat to their leverage. The proposal would allow the control board to mediate negotiations between Puerto Rico’s government and creditors and if the board deemed it necessary, to facilitate a court sanctioned restructuring. Such a restructuring would apply to all of Puerto Rico’s debt—what creditors are calling Super Chapter 9. The draft also proposes a stay for all debt litigation upon enactment.

The government faces a $422 million debt payment on May 1 and another $2 billion payment on July 1, and it is unclear whether it has the funds to pay either of them. That’s put increased pressure on Congress to come up with a solution. The Natural Resources Committee plans to hold a hearing on a final discussion draft the second week in April and proceed to a markup of the full legislation soon thereafter. The Senate is likely to move quickly as well.

The big worry is that the Puerto Rican deal might start to resemble the fallout from the Greek financial crisis, where strict bailout requirements from the European Union and the IMF have fostered unrest in Greece amid complaints that Europe is undermining its sovereignty. Puerto Rico’s situation isn’t quite the same—it’s not its own country, and isn’t seeking a bailout—but critics say the European experience demonstrates the need to have buy-in from the local population. And that buy-in is premised on allowing elected, democratically-accountable leaders to make the final policy decisions.

“Contrary to D.C., which is a city, in dealing with Puerto Rico, you would have to assume that you’re dealing with Connecticut,” said Luis Fortuno, a former governor of Puerto Rico. “And the question that should be asked is whether this level of attention to every single detail would work in Connecticut or not? And I would say probably not.”

Even opponents of the discussion draft believe that some form of a board is necessary for Puerto Rico. One recent poll found that 71 percent of Puerto Ricans favor an oversight board. But the details of the control board are important. Pedro Pierluisi, the island’s non-voting representative in Congress who supports the concept of an oversight board, has said that the current requirement that Puerto Rico achieve five consecutive balanced budgets before the board terminates is too many. He suggests three years instead. Furthermore, both critics and opponents of the discussion draft agree that the board should be made up of people who have a deep familiarity with Puerto Rico.

“You want to make sure that these are done by Puerto Ricans and people with a nexus to the area,” said Davis.

But there is no agreement over the control board’s authority. The ultimate question is whether it should have an advisory role—or have the power in this week’s proposal: the ability to override the elected public officials of Puerto Rico.

“When you have a group that has presided over financial disaster, what has to happen is control is taken away from them and put in the hands of responsible people,” said Alex Pollock, a senior fellow at the R Street Institute who testified before Congress about a control board for Puerto Rico. “It does not mean that all will be a lovefest and wine and roses—almost certainly not. But in the situation, there’s no way it’s going to create a lovefest.”