With Puerto Rico, Get Over Your 'Principled Opposition'
Conservative Republicans have added Puerto Rico debt restructuring legislation to the list of House Leadership priorities they oppose, with 10 of 24 Republicans on the Natural Resources Committee voting against the bill on May 25. Throwing sand into the legislative gears as a way of expressing principled opposition is sometimes appropriate, but the principle ought to be a good one. Obstructionism to prevent wasteful spending and crony capitalism may be justified, but when it comes to opposing the Puerto Rico Oversight, Recovery and Modernization Act (PROMESA), the cause is dubious at best. As the bill comes to the floor, conservatives should ask themselves whether there is a principle worth fighting for, or whether special interests have fooled them into defending cronyism.
501c4 groups opposed to the debt adjustment regime in PROMESA paint it as a federal bailout for the island, even though the bill does not include any new federal spending. Instead, these groups oppose a provision of the bill that gives a federal oversight board and Puerto Rico courts the power to impose a settlement on bondholders. But any reduction in principal or interest payable to bondholders actually lowers Puerto Rico government spending and thus the burden on taxpayers, both on the island and on the mainland - since one third of Puerto Rico Commonwealth spending comes from federal grants.
The only federal taxpayers that will be adversely affected by debt restructuring are those that purchased Puerto Rico bonds directly or through a municipal bond fund. Since most municipal funds have limited exposure to Puerto Rico, fund investors can expect minimal losses. Investors who took concentrated positions in Puerto Rico debt knew, or should have known, that these securities carried elevated risk. Puerto Rico bonds have had relatively low credit ratings and high yields for several years.
Some investors object to the fact that the bill changes the rules in the middle of the game by allowing a bankruptcy option after the bonds were issued. Because Puerto Rico is excluded from Chapter 9 of the bankruptcy code, the island's instrumentalities cannot use it to restructure debt. But the absence of a bankruptcy process is not a protection against default. Thousands of US municipalities defaulted on municipal bonds prior to the addition of Chapter 9 to the bankruptcy code back in 1934. That Depression-era measure, which passed with bipartisan support, even appealed to many bond investors because it brought order to the chaos in the municipal bond market.
Now we are confronted by a chaotic series of defaults in Puerto Rico. Since Chapter 9 does not apply to that territory, Congress is using its authority under the Constitution's Territorial Clause to implement a procedure to address one territorial government's inability to fulfill its commitments. The fact that the legislation derives from the Territorial Clause makes it inapplicable to US states, contrary to the contention of bill opponents.
Further, the idea that relatively indebted states like Illinois would want to take advantage of PROMESA is far-fetched. The debt restructuring benefits of PROMESA come at the cost of strict federal oversight under which an appointed board can alter the legislatively approved budget. Also, analogies to US states are overdone: while Puerto Rico's bonded debt and unfunded pension liabilities exceed 100% of GDP, in Illinois, these obligations account for only a third of state output.
So if PROMESA is faithful to the Constitution, doesn't cost the taxpayer's money and won't disrupt the municipal bond market in the fifty states, exactly what conservative principle is violated by this measure? That's a question best put to those funding the issue ads attacking the bill. But since the ads are being run by a dark money group, we don't know who those funders are. However, lobbying disclosures reveal that the main opponents of PROMESA are hedge funds and municipal bond insurers.
Some hedge funds appear to have bought Puerto Rico debt at discounted levels, and hope to litigate their way to major gains - as Paul Singer did with Argentina bonds. Municipal bond insurers, like Assured Guaranty and National Public Finance Guaranty, cover $12 billion of Puerto Rico debt. Every dollar of insured principal and interest written off in a restructuring process will hit the balance sheets of these companies, but Wall Street appears to have concluded that the impact won't be fatal.
These interests oppose PROMESA because it limits their ability to litigate. If a two-thirds majority of bondholders in a given class accept a settlement, the federal oversight board can impose that deal on holdouts - which would typically be hedge funds and municipal bond insurers.
It is unfortunate that hedge funds won't make a killing and that bond insurers will lose money, but these worries should not be the concern of Congress. Those who came to Washington to offer a principled defense of the public purse and the Constitution should not be misled into championing the priorities of financial interests seeking to maximize their returns on tax-supported bonds. Conservative Republicans should get behind PROMESA when it reaches the house floor.