Antonio Weiss, the former Wall Street banker who became a top adviser to the Treasury secretary this year, has made two trips to Puerto Rico in recent weeks.
Kent Hiteshew, who runs the Treasury Department’s office of state and local finance, has also met with government officials in San Juan multiple times this spring.
The Treasury Department is quietly stepping up its involvement in Puerto Rico, indicating that the island’s financial problems, which have been simmering for years, are reaching a critical point. High-ranking officials have been shuttling between Washington and Puerto Rico, advising commonwealth officials as they try to stabilize the island’s finances.
But it is a quandary with no clear-cut solution and potentially far-reaching effects. Puerto Rico is struggling with far more debt than analysts believe it can repay, and no legal framework exists to reduce the burden. Financially troubled cities and counties in the United States can take shelter in bankruptcy court, but federal law denies that option to U.S. territories and commonwealths, and attempts to amend the law face an uphill battle.
Neither a federal bailout nor a takeover of the island’s finances by the Treasury is under discussion, according to officials briefed on the matter who spoke on the condition of anonymity.
“The big issue is liquidity, which they seem to be running out of quickly,” said Joseph Rosenblum, director of municipal credit research at AllianceBernstein, which over the last few years has sold nearly all its Puerto Rico debt holdings.
On a per-capita basis, Puerto Rico’s debt load of $73 billion is bigger than that of any state. Much of it is owned by middle-class Americans who bought the island’s municipal bonds indirectly, as part of their retirement accounts, so any default would reverberate far past Puerto Rico’s shores. But to avoid a default in the near term, Puerto Rico has little choice but to add to the mountain of debt and is seeking to borrow as much as $2.9 billion more this spring.
Treasury officials have been encouraging the commonwealth to come up with a long-term fiscal plan and to find ways to maintain credibility with skittish bond investors, who are proposing increasingly stringent demands before they will lend more money.
A group of hedge funds, for example, is demanding that as one condition of lending $2.2 billion to Puerto Rico, lawmakers must balance its budget for the long haul or agree to be found in default if a gap emerges — an almost unheard-of requirement in the municipal bond market, where cities have access to credit no matter how many gimmicks it takes to close their books. The bond would be paid for by a fuel tax, a proposal that has angered some island residents who say the government is putting the needs of Wall Street creditors over those of the general populace.
Treasury officials are steering clear of negotiations between the commonwealth and the hedge funds, but they are encouraging the government to find ways to stabilize its finances beyond borrowing more money, the people briefed on the matter said.
For years, Puerto Rico has bounced from one bond deal to the next, borrowing billions of dollars to fill budget gaps or to make interest payments on previous debt. Investors, for the most part, have been willing to lend the government as much money as it wanted because the yields on the bonds were so lucrative and the interest on the bonds is tax-exempt to investors in all 50 states. The commonwealth’s pledge to pay back its debts also seemed ironclad.
But that changed last summer when lawmakers passed the so-called Recovery Act, which would give the commonwealth the legal tools it needed to restructure the debt of some of its public corporations. The law threatened longstanding protections for bond investors and seemed to conflict with officials’ claims that Puerto Rico intended to pay its debt. A federal judge ruled the restructuring law was invalid, and the commonwealth has appealed. But Puerto Rico’s credibility with investors and credit analysts was badly damaged.
Further fanning investors’ fears was a recent proposal by a group of Puerto Rico lawmakers that would effectively allow the commonwealth to default on its general obligation debt.
Even though such proposals appear to lack broad support in the legislature, credit analysts say that at least one Puerto Rico municipal bond issuer, the Puerto Rico Electric Power Authority, is likely to default on its debt this year. Moody’s Investors Service expects that the power authority will skip a debt payment that is coming due in July.
“Puerto Rico has indicated it is no longer going to move heaven and earth to support its debt,” said Ted Hampton, a senior analyst at Moody’s, which rates Puerto Rico debt as junk. “That’s a major divergence from past practice and policy.”
As Puerto Rico’s problems deepen, existing creditors are grabbing whatever security they can to protect their investments. Normally, a hierarchy of creditors emerges in a bankruptcy case, but because Puerto Rico cannot seek bankruptcy court protection, it is not clear how its various types of debts and creditors would be ranked.
Municipal bond holders are still recovering from the shock they endured in Detroit’s recent bankruptcy, where the city’s bonds were impaired more sharply than the city’s pensions, and some debt instruments were threatened with outright repudiation.
Investors who hold some of the $9 billion of debt issued by Puerto Rico’s electric power authority fear something similar could happen to them. With cash getting tight this summer, they think the government may default on those bonds to conserve cash to pay other debts, especially general-obligation bonds, which have a constitutional guarantee.
Investors in the electric authority’s bonds have already offered debt forbearance and extended it several times, in hopes of getting a consensual restructuring deal. Another deadline falls on Wednesday, and the Puerto Rican legislature will hold a hearing on Tuesday on why there has been so little visible progress. If the talks fail, and the electric authority defaults, it could chill appetites for the $2.2 billion of new debt for the commonwealth that the hedge-fund group has been pushing.
Investors think the public would rally to the cause of nonpayment, because electric rates are high on the island and service is poor.
Many investors are putting their faith in the federal government to find a way to sort out the mess.
Some bond investors have suggested that, should Puerto Rico get shut out of the debt markets, the Government Development Bank could borrow from the Federal Reserve’s discount window, just as teetering Wall Street banks did during the financial crisis.
But the Government Development Bank, which oversees the commonwealth’s debt deals and lends money to the island’s municipalities and public corporations, is not a traditional bank. It may not be impossible for the bank to borrow from the Fed, but it would face multiple regulatory hurdles to qualify for access to the discount window.
Hedge funds that own more than a quarter of the island’s debt have also raised the possibility that Puerto Rico could be placed under some kind of federal receivership or control board like the one the federal government imposed on Washington in the 1990s. Because Puerto Rico is a commonwealth, they argue, the federal government could also take over its finances.
A federal takeover seems unlikely, particularly because Puerto Rico’s residents have debated for years about whether they want to remain a commonwealth, become a state or break away entirely from the United States. A control board could exacerbate these tensions.
“It would be offensive. It would show a lack of respect,” said Pedro R. Pierluisi, who is Puerto Rico’s representative in Congress.
Puerto Rico’s relationship with the federal government is a double-edged sword. On one hand, its residents, many of whom pay no federal income tax, receive a lot of federal aid — an estimated $6 billion this fiscal year. That is down from $6.3 billion in fiscal year 2014. That money supports a range of benefits like water treatment in Puerto Rico’s rural areas and children’s nutrition programs.
On the other hand, Puerto Rico lacks a full voting member in Congress, where a key initiative to sort out its debt problem now lies.
Pierluisi, who cannot vote on the House floor, has proposed a bill that would allow some of the commonwealth’s public corporations, like the electric authority, to seek federal bankruptcy protection.
The bill has drawn the ire of a Tea Party group and the lobbyists hired by some of the investors that own the public corporations’ bonds.
“I want insolvencies in Puerto Rico to be handled the American way,” Pierluisi said.