No compromise is perfect: Time to accept Puerto Rico debt agreement

Pain is painful, in particular for policymakers confronted with tough decisions and difficult compromises. And so kicking the can down the road is a time-honored fallback position for the political class, especially when voters prefer to see “wins” on their behalf as distinct from nuanced solutions to difficult problems.

But the consequences of this political reality can be dire, as eventually the end of the road is reached. That is where we find ourselves in the context of the debt crisis confronting the commonwealth of Puerto Rico.

A bit of background: A compromise between Congress and the Obama administration early last summer allowed Puerto Rico to avoid a very likely default on its massive $69 billion debt, of which $9 billion is owed by the Puerto Rico Electric Power Authority (PREPA).

It was only in February 2016 that a deal (the Restructuring Support Agreement, or RSA) was worked out between the island government and the holders of debt issued by PREPA, which then was signed into law by then-Gov. Alejandro García Padilla.

{mosads}And a bill last summer between Congress and the Obama administration — the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) — created an oversight board with the power to restructure the massive overall debt and to force budget and other reforms yielding fiscal discipline over the longer term. It also halted litigation over debts that had been defaulted.

Let the record show that the agreed-upon PREPA RSA imposes very substantial concessions — economic losses — upon the bondholders: A 15 percent reduction in bond debt, a 20 percent interest rate cut providing at least $1.1 billion in debt service relief over the first five years and at least $1.7 billion over the first decade, and a deferral of principal payments for over five years. And under the agreement, PREPA customers would pay electricity rates almost 40 percent lower than the average rates paid in (ascending order) Hawaii, Haiti, St. Lucia, Grenada, the Dominican Republic and the Virgin Islands.

The RSA was approved by the Puerto Rico legislature. It was approved by the independent Puerto Rico Energy Commission. As fuel prices have declined — about half of the island’s power is generated with oil — the financial benefits have flowed to commonwealth ratepayers in the form of lower power rates, rather than to bondholders as increased debt service.

Already in default on about $8.9 billion, PREPA owes a bond payment of $455 million on July 1. PREPA’s most recent public disclosure shows that the utility this June will have minimum liquidity of $200 million only if it defaults completely on the July payment; and liquidity of minus $256 million if it makes the July payment, and attendant capital requirements of $408 million by August.

Can anyone believe that a default on the July payment will allow continued access to the capital market?

So why would the RSA not be implemented? The answer: The new governor, Ricardo Rosselló Nevares, for months has refused to approve it and move forward, for the obvious reason that for political reasons he wants to be seen to be imposing more pain on the bondholders.

On March 21, it was made public that the governor’s plan to achieve this is a drastic rewriting of the PREPA RSA, so as to force the bondholders to accept new lower-rated bonds for which there would be no debt service for seven years. The bondholders responded by stating that the proposal is “unworkable” and would “undermine the value and structural integrity” of the new bonds under the agreed PREPA RSA that, as noted above, already impose large concessions on the bondholders.

Then it was reported that the bondholders had made a new counteroffer and agreed to give the governor another extension (until this Wednesday) to make a final decision. While the precise terms remain confidential, the reports note that the new proposed terms would provide further relief for commonwealth ratepayers.

In the meantime, the clock is ticking on more than this new deadline. If a new deal is not finalized, the issue is when — not if — PREPA will run out of cash. At that point, it is not clear how the lights will be kept on and how the island’s economy, already afflicted with serious unemployment and other problems, will be protected from collapse, as the availability of electricity is no small matter.

If PREPA defaults yet again on its debt service, and the previous agreed RSA is not honored, it is difficult to see how Puerto Rico will be able to find financing for its many capital needs.

This obvious reality is so serious that Rep. Doug LaMalfa (R-Calif.), the chairman of the House Subcommittee on Indian, Insular and Alaska Native Affairs (Committee on Natural Resources), wrote on March 28 to Rosselló, pointing out that the PREPA RSA “is deemed a ‘preexisting voluntary agreement’ that meets the requirements of … PROMESA. Furthermore, POMESA contemplated protecting and preserving any voluntary agreements prior to its enactment; the PREPA RSA is the only such agreement of its kind.”

LaMalfa continued:

Given the magnitude of debt and the severity of the risk associated with a failure to reach any agreement before the looming deadline, success in finalizing the PREPA RSA would set the crumbling utility on a sustainable path towards reliable, cost efficient power generation and a reentrance to the credit markets. As your Administration begins the arduous task of negotiating with creditors on the remaining $63 billion of debt, it is of vital importance that Puerto Rico shows the Oversight Board and the financial markets that your Government respects preexisting voluntary agreements; the PREPA RSA presents a rare opportunity to showcase just that.

Can anyone disagree with a single one of those observations? Let us go further: Even if Rosselló is able to squeeze more concessions out of the PREPA creditors, that will yield even greater future wariness on the part of the capital market with respect to purchases of commonwealth bonds, and thus a smaller market and higher interest costs. Can it possibly be the case that Rosselló does not recognize this?

It is essential for the citizens of Puerto Rico as well as for the PREPA creditors — who now have extended the RSA 16 times — that the RSA be implemented and that the processes of restructuring and economic reform move forward.

It is time to accept the reality that no compromise is perfect, but in this case the alternative is likely to be disastrous.

Benjamin Zycher is the John G. Searle Scholar at the American Enterprise Institute.

The views of contributors are their own and not the views of The Hill.