    [Senate Hearing 114-880]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 114-880

                         PUERTO RICO'S FISCAL PROBLEMS:
                            EXAMINING THE SOURCE AND
                             EXPLORING THE SOLUTION

    =======================================================================

                                    HEARING

                                   BEFORE THE

                           COMMITTEE ON THE JUDICIARY
                              UNITED STATES SENATE

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                DECEMBER 1, 2015

                                   __________

                               Serial No. J-114-41

                                   __________

             Printed for the use of the Committee on the Judiciary

    [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                            www.judiciary.senate.gov
                                www.govinfo.gov

                                    __________

                       U.S. GOVERNMENT PUBLISHING OFFICE
    52-553                  WASHINGTON : 2025

    -----------------------------------------------------------------------------------

                           COMMITTEE ON THE JUDICIARY

                      CHARLES E. GRASSLEY, Iowa, Chairman
    ORRIN G. HATCH, Utah                 PATRICK J. LEAHY, Vermont, Ranking
    JEFF SESSIONS, Alabama                   Member
    LINDSEY O. GRAHAM, South Carolina    DIANNE FEINSTEIN, California
    JOHN CORNYN, Texas                   CHARLES E. SCHUMER, New York
    MICHAEL S. LEE, Utah                 RICHARD J. DURBIN, Illinois
    TED CRUZ, Texas                      SHELDON WHITEHOUSE, Rhode Island
    JEFF FLAKE, Arizona                  AMY KLOBUCHAR, Minnesota
    DAVID VITTER, Louisiana              AL FRANKEN, Minnesota
    DAVID PERDUE, Georgia                CHRISTOPHER A. COONS, Delaware
    THOM TILLIS, North Carolina          RICHARD BLUMENTHAL, Connecticut

          Kolan L. Davis, Republican Chief Counsel and Staff Director
          Kristine Lucius, Democratic Chief Counsel and Staff Director

                               C O N T E N T S

                                  ----------

                               OPENING STATEMENTS

                                                                       Page

    Grassley, Hon. Charles E.........................................     1
        Prepared statement...........................................    36
    Schumer, Hon. Charles E..........................................     5
        Prepared statement...........................................    39
    Blumenthal, Hon. Richard.........................................     3

                                   WITNESSES

    Carrion, Richard.................................................    16
        Prepared statement...........................................    50
        Responses to written questions...............................   138
    Colon De Armas, Carlos A.........................................    11
        Prepared statement...........................................    59
        Responses to written questions...............................   140
    Garcia Padilla, Alejandro J......................................     7
        Prepared statement, dated October 22, 2015...................    42
        Prepared statement, dated December 1, 2015...................    97
    Pierluisi, Pedro R...............................................     8
        Prepared statement...........................................    99
    Pollock, Alex J..................................................    14
        Prepared statement...........................................   101
        Responses to written questions...............................   146
    Ravitch, Richard.................................................    17
        Prepared statement...........................................   108
        Responses to written questions...............................   148
    Spencer, Stephen J...............................................    12
        Prepared statement...........................................   110
        Responses to written questions...............................   151

                                    APPENDIX

    Items submitted for the record...................................   163

                         PUERTO RICO'S FISCAL PROBLEMS:
                          EXAMINING THE SOURCE AND
                          EXPLORING THE SOLUTION

                                  ----------

                           TUESDAY, DECEMBER 1, 2015

                                  United States Senate,
                                    Committee on the Judiciary,
                                                        Washington, DC.
        The Committee met, pursuant to notice, at 10 a.m., in Room
    226, Dirksen Senate Office Building, Hon. Charles E. Grassley,
    Chairman of the Committee, presiding.
        Present: Senators Grassley [presiding], Hatch, Lee, Perdue,
    Tillis, Schumer, Durbin, Klobuchar and Blumenthal.

             OPENING STATEMENT OF HON. CHARLES E. GRASSLEY,

                 A U.S. SENATOR FROM THE STATE OF IOWA

        Chairman Grassley. This is how we planned the hearing, that
    I am going to give an opening statement, Senator Blumenthal is
    going to give an opening statement, and if Senator Schumer
    comes, he will give an opening statement because he can't stay
    around for Q&A. And then we're going to call on the Governor
    and the Congressman, and it's my understanding we have agreed
    that we will listen to the Congressman and the Governor and not
    have questions of them. And then we will go to our second
    panel.
        The purpose of today's hearing is to learn more about the
    origins of Puerto Rico's fiscal problems and what's needed to
    help restore fiscal balance and economic growth. It's my hope
    that we will have a valuable discussion based on facts and
    informed by our witnesses' expertise.
        Puerto Rico's debt crisis didn't happen overnight. It has
    been years in the making. Fundamentally, the starting point for
    any solution is to first identify the problem and understand
    its size and scope. Unfortunately, confusion reigns as Puerto
    Rico has failed to provide audited financial statements for the
    past 2 years.
        What we do know is that for many years as Puerto Rico's
    economy suffered, debt and spending increased to the point
    where the isle--island lost investor confidence. Puerto Rico
    has defaulted on certain debt obligations, lost access to the
    normal markets, and now faces a liquidity crisis. The Governor
    and others have stated that the island's current debt ``is not
    payable.''
        Puerto Rico's economy has suffered for decades, in part,
    because of barriers to job creation and labor force
    participation. The Federal minimum wage mandate, generous
    entitlement programs, red tape and the bureaucracy, and a
    bloated public sector have stifled business activity. This has
    a direct impact on Puerto Rico's residents. They are, of
    course, our fellow U.S. citizens. High unemployment rates have
    resulted in a declining population as Puerto Ricans have left
    the island to search for better jobs. A diminished population
    means lower tax revenues to fund government.
        Despite these long-term economic challenges, for many years
    Puerto Rico maintained a balanced budget and high credit
    ratings on its debt. So, what then led to the fiscal crisis
    that the island faces today? While the economic challenges may
    be debatable, it's clear that since 2000, Puerto Rico's public
    debt has risen from 60 percent of GDP to now more than 100
    percent. This is an indication of serious fiscal mismanagement.
        Thanks to the highly attractive triple-tax exempt status of
    its bonds, it was easier for the island to borrow and paper
    over deficits rather than address financial shortcomings and
    economic realities in order to balance the budget. The
    consequence of this decision is an accumulation of
    approximately $72 billion of debt, arising from roughly 17
    different debt issuers. This includes more than $18 billion in
    constitutionally protected general obligation debt and also
    around $24 billion in debt issued by public corporations, like
    the Puerto Rico Electric Power Authority.
        Moreover, because of its triple-tax exempt status, a wide
    array of investors own Puerto Rican bonds. According to
    Bloomberg, Puerto Ricans alone hold $20 billion of the debt.
    And nearly 60 percent of Puerto Rico's debt is held largely in
    the individual retirement accounts and 401(k)'s of regular
    folks throughout the United States. I am told that
    approximately 16,000 Iowans are invested in funds that hold
    PREPA bonds. And, of course, these folks aren't vultures. They
    are middle-class Americans who probably knew little about
    Puerto Rico's finances. They simply invested in one of the many
    tax-exempt municipal bond funds containing Puerto Rico's bonds.
        Notwithstanding all of this, we are told that Puerto Rico's
    debt needs to be restructured in order to address its fiscal
    challenges. Puerto Rico, though, lacks access to an orderly
    debt restructuring mechanism, like Chapter 9 of the Bankruptcy
    Code. Thus, Congress has been called upon to extend Chapter 9
    to Puerto Rico's public corporations, or to create a broad new
    bankruptcy regime that people have dubbed as ``Super Chapter
    9'' to restructure all debt, including the island's
    constitutionally guaranteed general obligation bonds. According
    to a recent New York Times article, quote, ``advisers to the
    island's government have been urging the Governor to default on
    the debt, saying that the only a catastrophe would move
    Congress--especially Republicans--to help,'' end of quote. I
    hope the Governor will tell us whether this is accurate. If so,
    it would trouble to me greatly if true.
        This is not the first time Congress has been asked to help
    address a situation like Puerto Rico now faces. In the past, we
    have provided help in a bipartisan way. During the 1990s, the
    District of Columbia faced a fiscal crisis, as it was insolvent
    and unable to pay. Congress worked with the District and the
    Clinton administration officials to pass the District of
    Columbia Financial Responsibility and Management Assistance Act
    in 1995. We'll hear more about the response to that crisis and
    others from our witnesses today. I'll note that Congress
    considered extending Chapter 9 to the District of Columbia, but
    decided that there was, quote, ``little practical significance
    or advantage to such a legislative gesture,'' end quote. The
    Committee report to that bill stated, quote, ``the issues
    facing the District of Columbia...require political and
    structural, as well as financial remediation,'' end of quote.
        One of the reasons extending Chapter 9 to the District was
    rejected is because it is designed primarily to restructure and
    decrease municipal debt, the idea being that relief from
    creditors is what is needed in order to gain a fresh start. But
    Chapter 9 cannot bring about financial rehabilitation. It does
    not increase economic growth or alter the fundamental fiscal
    trajectory. In short, Chapter 9 cannot address the root causes
    of fiscal problems, but instead pushes them off to future
    generations.
        As for Super Chapter 9, this is something that no State can
    do and has been described as, quote, ``unprecedented in the
    American context,'' end of quote. It would be a bad idea, with
    negative consequences, for Congress to permit Puerto Rico to
    walk away from its constitutional debt obligations. Unlike
    other bonds, constitutional debt, whether issued by Puerto Rico
    or any of our States, has that government's full faith and
    credit commitment to repay the debt.
        And let us not forget that Puerto Rico issued its bonds
    with the knowledge that Chapter 9 bankruptcy wasn't an option
    for--in the event of a default. Is it fair to retroactively
    change the rules at the expense of these investors if other
    options exist for addressing Puerto Rico's debt problems? At
    least--at the very least, this is an idea that should be at the
    end of the line, not at the front of the line.
        The challenges Puerto Rico face are great and require more
    than just short-term solutions that don't provide long-term
    relief. The debt is a symptom of a bigger problem. Merely
    extending debt restructuring authority, absent tools to address
    the fundamental causes of the fiscal problem, is not a long-
    term solution that will help Puerto Rico.
        Puerto Rico has struggled to make the difficult decisions
    to cut spending and balance its budget. If Congress is to act,
    then we must ensure that Puerto Rico has the tools to help
    itself out of this situation. Today's hearing can help us
    identify what may, or may not, need to be considered for Puerto
    Rico to get its balance sheet back in order. Senator
    Blumenthal.

             OPENING STATEMENT OF HON. RICHARD BLUMENTHAL,

              A U.S. SENATOR FROM THE STATE OF CONNECTICUT

        Senator Blumenthal. Thank you, Mr. Chairman. I particularly
    want to thank you for having this hearing and other colleagues
    on the Committee for your contributions this morning and over
    the past months. Most especially Senator Hatch as Chairman of
    the Finance Committee, I know has been working diligently, and
    I want to welcome our two first witnesses who have really
    dedicated themselves to addressing and solving these problems,
    which are so intractable and difficult, so that our fellow
    Americans--and they are our fellow Americans in Puerto Rico,
    3.5 million United States citizens--can be saved from the
    financial and humanitarian catastrophe and calamity that
    threatens them and really our entire country, because we will
    all be affected by the catastrophe that threatens here.
        What Congress does or fails to do with respect to Puerto
    Rico will have indeed a massive impact not only on those 3.5
    million fellow Americans but throughout the financial--
    financial market in the United States and possibly even around
    the world. And it will send a profoundly significant message
    about the Federal Government's moral responsibility well beyond
    our financial obligation, our moral responsibility to look out
    for fellow Americans regardless of where they live.
        There has been a lot of discussion about how we got here.
    We should always learn from history so we don't repeat it. But
    right now this crisis demands action. Many of us remember the
    headline that appeared in the newspapers not so long ago in
    American history that was, in effect, Congress to New York,
    ``Drop dead.'' Congress cannot tell Puerto Rico to drop dead
    financially anymore than it could New York or any other State
    represented by my colleagues here today. What Puerto Rico needs
    is very simply the authority to address and deal with its
    financial problems and authority is lacks simply by a quirk of
    history. And reasonable people may disagree about the details
    of the current situation, but one thing should be absolutely
    clear. This situation is unsustainable. The status quo is
    unacceptable. And we need to come together, regardless of party
    and geography, to fashion and craft a solution that enables
    Puerto Rico to restructure its debts under the auspices of a
    court.
        Working with my colleagues like Senator Schumer--and I want
    to thank him for his leadership as well--Senator Menendez,
    Senator Gillibrand, and Nelson, I have put forward a plan for
    moving forward. The plan begins by recognizing, as one of the
    Republican witnesses at this hearing has said, that debts
    cannot be--debts that cannot be repaid will not be repaid.
    Debts that can't be paid back will not be paid back. Puerto
    Rico can and must reform itself, but no amount of long-term
    reform will address the short-term reality that Puerto Rico
    cannot pay its current debts when due. That is the definition
    of insolvency, both in law and practical reality.
        The only question is whether this reality results in a
    messy and chaotic default with nobody winning except the
    legions of predators' attorneys who will spend years, countless
    billable hours, fighting each other. As we have seen for more
    than a decade in the case of Argentina, the alternative is an
    orderly restructuring which served the public interest as well
    as the interests of our fellow Americans in Puerto Rico. If we
    prefer an orderly, rational, deliberative, productive process,
    Congress must act.
        Puerto Rican--Puerto Rico also needs and deserves equal
    treatment under the Earned Income Tax Credit, the Child Tax
    Credit, and Federal health care programs. Not only will equal
    treatment alleviate suffering among Puerto Rico's people, it
    will reduce pressure on the Puerto Rican government and free up
    resources to resolve the island's fiscal crisis.
        Others have different ideas about how to help Puerto Rico,
    and I appreciate those ideas and my colleagues who have offered
    them on both sides of the aisle. I am open to any proposal that
    will actually solve the problem. What is essential is that we
    act, and we must act before it is too late.
        I want to close by making one thing really completely clear
    here. Congress, generally, and this Committee, in particular,
    are at a crossroads. Puerto Rico is at a crossroads, but
    America is at a crossroads in addressing the needs of 3.5
    million Americans but our financial markets and our moral
    obligation. Eight percent of Puerto Ricans have fled the island
    since 2006 as a result of diminished economic opportunity.
    Eighty-four thousand Puerto Ricans came to the mainland last
    year alone. Those are numbers you see after an armed conflict
    or a disaster. They are a mark of tragedy on an island that
    deserves better. And if Congress fails to act, the situation
    could become much worse.
        Just today, Puerto Rico has narrowly averted a complete
    default that could have hobbled its government, including its
    ability to provide education, law enforcement, health care, and
    other essential services. It avoided this default only by
    resorting to unsustainable financial gymnastics. Let's be very
    blunt and real. Those financial gymnastics cannot be sustained
    or continued indefinitely. The financial somersaults and
    headstands must end.
        The prospect of a humanitarian catastrophe within the
    United States territory is very real, and it is very immediate.
    Congress can act to prevent this catastrophe, or it can choose
    not to do so. If we fail that, the responsibility is ours. I
    know that Members of this Committee will address rather than
    shirk that responsibility, and I look forward to working with
    all of my colleagues in the coming days. Thank you, Mr.
    Chairman.
        Chairman Grassley. Thank you. It is my understanding that
    Senator Schumer has to go.
        Senator Schumer. I do.
        Chairman Grassley. You asked if he could speak. Go ahead.

             OPENING STATEMENT OF HON. CHARLES E. SCHUMER,

               A U.S. SENATOR FROM THE STATE OF NEW YORK

        Senator Schumer. Thank you, Mr. Chairman, and I very much
    appreciate your letting me speak and, more importantly, having
    this hearing. It is such an important issue. There are
    different views in this Congress. But just ignoring them and
    sweeping them under the rug will accomplish nothing. So, thank
    you so much for holding the hearing.
        And let me just say I am committed to finding a solution to
    help not just the 3.5 million Americans living in Puerto Rico
    but the additional 5.2 million living in the United States,
    including over 1 million in New York. These are brothers and
    sisters, sons and daughters, uncles and aunts, worried about
    the quality of life of their relatives and friends living on
    the island, and they deserve the peace of mind to know that
    Americans, no matter where they live--on the mainland or on the
    island--are Americans and are entitled to the same rights and
    quality of life we all expect. We have a basic American
    responsibility to answer that call, to aid all American
    citizens in times of crisis, regardless of where they live.
        So, Mr. Chairman, here is the bottom line. The Puerto Rican
    people can no longer wait. They can no longer wait for Congress
    to give them the tools they need to address a disastrous
    financial crisis. The situation in Puerto Rico grows more dire
    each month, and my good colleague and Co-Sponsor--lead sponsor
    on our bill has laid that out.
        The bill we have put forward, Senator Blumenthal and I, the
    Puerto Rican Chapter 9 Uniformity Act, that many of my
    colleagues on this Committee also support, provides Puerto Rico
    with the authority to access Chapter 9 protections and would be
    a significant step in the right direction, allow them to begin
    to climb out of this financial hole.
        I recognize, of course, that there's more that can be done
    and more that should be done. I have never said that our
    Chapter 9 bill would be a silver bullet that solves all of the
    issues. There's no question in my mind Puerto Rico needs some
    restructuring authority. But there's much more we can do.
        I have introduced legislation to address several aspects of
    the health care crisis, including issues like Medicaid funding
    and fairness, appropriate Medicare reimbursement, equitable
    physician payments. The disparities in how the Medicare and
    Medicaid programs treat Puerto Rico versus the rest of the
    United States are significant and also need to be addressed.
        But today's hearing is focused on the legal authority that
    is appropriate to provide Puerto Rico to be able to
    sufficiently resolve the significant debt burden it faces, and,
    more importantly, Puerto Rico needs sufficient authority to
    compel all the creditors to come to the table. There are
    different creditors with different agendas. If they would all
    come to the table, we could get something done here. The
    legislation requires that, forces that to happen.
        I'm deeply concerned, if we are unable to address these
    issues and provide Puerto Rico with sufficient restructuring
    authority in the near term, we're going to see a humanitarian
    crisis develop on the island. The Puerto Rican people have
    already lost access to the capital markets, and should they
    default on more and more debt payments, it is a real worry we
    could see public services--health care, education, utilities--
    become scarce.
        Residents of the island have already begun to flee their
    homeland, as Senator Blumenthal mentioned. If the economic
    situation worsens, the population shift from the island to the
    mainland will continue until the only ones left are those who
    have no resources to move.
        So, the Puerto Rican people can no longer wait. This
    country can no longer wait. Congress must act now, and I thank
    my colleagues on both sides of the aisle not just for having
    the hearing, but for rolling up their sleeves and exploring
    what solutions can be agreed upon to address this important
    issue.
        I ask unanimous consent that the rest of my statement be
    added to the record, and I very much appreciate the courtesy of
    you, Mr. Chairman, Ranking Member Blumenthal today, and all the
    other Members to make my statement.
        Chairman Grassley. Thank you, Senator Schumer.
        Our first panel is Puerto Rican Governor Garcia Padilla and
    Resident Commissioner Pierluisi. I welcome both of you. Thank
    you for joining the Committee. We have asked each of you to
    provide us with a statement as we consider this very important
    issue. You have 5 minutes, and your complete statements will be
    put in the record. So, proceed, Governor.

                  STATEMENT OF THE HONORABLE ALEJANDRO

                    JAVIER GARCIA PADILLA, GOVERNOR,

                      COMMONWEALTH OF PUERTO RICO

        Governor Garcia Padilla. Thank you, Chairman Grassley,
    Ranking Member Blumenthal, and Members of this Committee.
    Puerto Rico is facing a crisis with severe consequences for the
    lives of 3.5 million American citizens on the island. More than
    300,000 have moved away in the last decade. Inaction by
    Washington at this time will only aggravate the state of
    affairs. A comprehensive solution is imperative. Give us the
    tool to make it happen.
        This hearing is proof enough--and I really appreciate it--
    that you are aware of the gravity of Puerto Rico's current
    state. On the other hand, one thing that I still hear
    frequently in the halls of this Congress is that we in Puerto
    Rico have not done enough to solve our problems. That's not
    true. My constituents have made significant sacrifices over the
    past 10 years, and the administration from both governing
    parties in Puerto Rico have implemented measures to shore up
    public finances. And while we may disagree on the effectiveness
    of the strategies, one thing is clear: We, the people of Puerto
    Rico, have done our part.
        Over the last decade, Puerto Rico has endured significant
    austerity measures. My administration has cut expenditures by
    over 20 percent of the budget. We have reformed our largest
    pension fund from defined benefits to defined contribution,
    including current employees. A new tax on pricing was put in
    place, and, most importantly, Puerto Rico is currently
    transitioning from a sales tax to a value-added tax with an
    11.5-percent rate. My administration has approved new revenue
    measures that impacted gasoline and water rates that are
    mentally--dramatically reducing government expenditures and
    froze collective bargainings. Public transportation routes have
    been cut, and we have been consolidating schools to improve
    education outcomes and force cost savings.
        The reduction in the government payroll has also been
    dramatic, 27 percent over the last 7 years, which is affecting
    already essential services. And massive outmigration is
    shrinking our tax base and is also in a death spiral. These
    austerity measures are in addition to the sales tax implemented
    in 2007 along with increasing tolls on water rates under the
    previous administration. Property tax rates were doubled. A new
    4-percent excise tax on the exports from foreign and U.S.
    corporations with manufacturing operations in Puerto Rico was
    legislated, and more than 30,000 public employees were laid
    off.
        We have taken significant austerity measures, and we will
    take additional ones if it is necessary. But the magnitude of
    the fiscal and economic problem bearing down on Puerto Rico is
    simply too large. We cannot solve this crisis alone, and
    Congress has a very important role to play.
        The loss of Section 936 benefits significantly contributed
    to the crippling of our economy and led directly to the
    recession that began in 2006. The 1984 amendments to exclude
    Puerto Rico from the Bankruptcy Code further aggravate the
    present crisis and lack, as First Circuit Judge Torruella
    noted, any rational base or clear policy reasons for their
    enactment. The imminence of a default when presented with the
    alternative between paying our creditors and providing
    essential government services looms large. Absent an orderly
    process, its effects will be catastrophic.
        That is why starting today the Commonwealth of Puerto Rico
    will have to claw back revenues pledged to certain bond issues
    in order to maintain essential public services. We have taken
    this difficult step in the hope that Congress will act soon.
    But let us be clear: We have no cash left. The emergency
    measures we have taken to avoid a default and maintain
    essential services are unsustainable.
        Members of the Committee, as you know, my request for
    immediate action, we have never asked Congress for a bailout,
    and we are not seeking one today. We ask for access to a legal
    framework to restructure our liabilities; fair treatment in
    Medicaid and Medicare funding; reforms that stimulate labor
    force participation; and tax measures that attract investment
    to Puerto Rico and create jobs; an exemption from the Jones
    Act, just like the one of our close neighbors, the United
    States Virgin Islands.
        Mr. Chairman, Members of the Committee, this is a distress
    call from a ship of 3.5 million American citizens that have
    been lost at sea since 199-1996. This is a distress call
    requesting tools to sail, not a bailout. We are asking for the
    tools to finish the job. It's your choice whether to answer or
    to disreg--disregard this call from the people of Puerto Rico.
    The cost of delay will be significant. The cost of inaction
    will be catastrophic.
        Again, please, give us the tools, and we will finish the
    job. Thank you so very much for your attention.
        [The prepared statement of Governor Garcia Padilla appears
    as a submission for the record.]
        Chairman Grassley. Thank you, Governor. Now, Congressman.

                  STATEMENT OF THE HONORABLE PEDRO R.

                  PIERLUISI, RESIDENT COMMISSIONER FOR

               PUERTO RICO, U.S. HOUSE OF REPRESENTATIVES

        Representative Pierluisi. Chairman Grassley, Ranking Member
    Blumenthal, and Members of the Committee, thank you for
    inviting me to speak on behalf of the island's 3.5 million
    American citizens I represent in Congress.
        When Puerto Rico becomes a State, as I know it will, my
    constituents will vote for the President and Members of
    Congress who make our laws, and they will be treated equally
    under those laws. Until then, Puerto Rico must depend on the
    goodwill of Senators and Representatives from the States. We
    must make the case for congressional action and hope you find
    it compelling. We are reduced to the role of a supplicant,
    pleading for equal treatment, or at least more equitable
    treatment.
        What a shameful arrangement--for us, but also for you.
        I believe in American exceptionalism--the concept that this
    country is unique in terms of its character and its conduct.
    But I also believe that the manner in which the Federal
    Government has treated Puerto Rico could cause one to question
    whether our Nation's devotion to democratic self-government is
    rhetorical rather than real.
        This is the fifth congressional hearing on Puerto Rico this
    year. At each hearing I have emphasized that Puerto Rico
    confronts a crisis for two reasons.
        First, over the years, the Puerto Rico government--with
    certain notable exceptions--has demonstrated a lack of
    discipline, transparency, and common sense when it comes to
    managing its finances and creating a business climate that
    attracts private investment, generates jobs, and grows the
    economy. Any individual that aspires to a leadership position
    in Puerto Rico should acknowledge that too many island
    officials have a record of overpromising and underdelivering
    and should have a credible plan to break this cycle.
        Second, the Federal Government's policies toward Puerto
    Rico are inequitable and incoherent. They essentially make it
    impossible for the island to prosper, even if our local leaders
    were beyond reproach.
        Just as Puerto Rico's leaders must concede their failures,
    this Congress must acknowledge its own responsibility.
    Introspection is a two--two-way street.
        For example, it is inexcusable that over 500 days have
    elapsed since the end of FY 2014 and the Puerto Rico government
    has not yet released an audited financial statement. Members of
    Congress are right to criticize Puerto Rico for such
    ineptitude. Just ask Senator Hatch yesterday.
        But let's place things in proper perspective. Puerto Rico
    has been treated 20/20 unequally under Medicaid and Medicare
    for 50 years, under the SSI and EITC programs for over 40
    years, and under the CTC program for nearly 20 years. The
    argument that Congress needs audited financial statements from
    Puerto Rico before it can act to rectify these devastating,
    decades--decades-long disparities defies logic.
        Faced with this lack of Federal economic support, and
    seeking to provide a decent quality of life for its people, the
    Puerto Rico government--unwisely but understandably--has
    overspent its own funds and overborrowed in the bond market.
    This has led to recurring deficits, a large debt, and the loss
    of over 60,000 residents a year through migration to the
    States.
        For both moral and practical reasons, Congress should
    swiftly enact a legislative package that gives Puerto Rico more
    equitable treatment under Federal programs. Of course, these
    provisions will cost money, just as it costs the Federal
    Government money every year when it spends $2.5 billion to
    support the Medicaid program in Iowa, or sends over $400
    million in checks to working families in Utah, or spends over--
    or provides $100 million to vulnerable individuals in Vermont
    under the SSI program. If Congress refuses to provide fair
    treatment to my constituents, they will continue to move in
    massive numbers to the States in order to obtain it. That is
    the logical consequence of an illogical system.
        This package should also authorize Puerto Rico to
    restructure a meaningful portion of its debt. We can have a
    reasonable debate about the scope and nature of this authority,
    which falls within the jurisdiction of this Committee, but at
    the very least, Puerto Rico should have the same ability to
    adjust its debts as the States. Providing this authority will
    cost the Federal Government nothing; whereas, failing to
    provide it will have an enormous humanitarian cost.
        If, but only if, Congress acts on these items that I have
    laid out, I will not oppose the creation of an independent
    board that respects the Puerto Rico government's primary role
    in crafting its budget and making fiscal policy, but that is
    authorized to ensure that the Puerto Rico government complies
    with appropriate budgeting standards and fiscal metrics. As I
    see it, this board should be redundant, because the Governor
    and Legislative Assembly of Puerto Rico ought to be conforming
    to such standards and metrics anyway, and so, I would not
    object to Federal oversight to make certain that they do.
        Five congressional hearings are enough. It is time for
    Congress to legislate and, in so doing, to be part of the
    solution to a problem it had a significant role in creating.
    Thank you.
        [The prepared statement of Representative Pierluisi appears
    as a submission for the record.]
        Chairman Grassley. Thank you, Congressman. Thank you,
    Governor. You are free to go, and now we will call the second
    panel.
        [Pause.]
        I am going to introduce the panel while you are coming up.
    Turning to our second panel of witnesses, Dr. Carlos Colon de
    Armas is a professor of finance, Graduate School of Business,
    University of Puerto Rico. Prior to that he served as executive
    vice president for Government Development Bank for Puerto Rico.
    He has an undergraduate degree from the University of Puerto
    Rico and a Ph.D. from Purdue.
        Stephen Spencer is a managing director, Financial
    Restructuring Group of Houlihan Lokey, where he focuses on
    advising companies in executive distress recapitalizations. He
    has represented creditors in several municipal restruct--
    restructurings resulting in significant experience on municipal
    finance issues. He received an undergraduate degree from the
    University of Wisconsin, Madison.
        Alex Pollock is a resident fellow at the American
    Enterprise Institute, Washington, DC, where he works on several
    policy issues, including the role of uncertainty and risk of
    financial systems. From `91 to 2004, Mr. Pollock served as the
    President and CEO of the Federal Home loan Bank board--Federal
    Loan Home Bank of Chicago. He has an M.P.A. from Princeton
    University, an M.A. from Chicago U and a B.A. from Williams
    College.
        Richard Carrion is chief executive officer of Popular Inc.,
    which is the largest banking institution by both assets and
    deposits in Puerto Rico. He spent more than 35 years working in
    banking at Popular. He has a master's degree from MIT and a
    bachelor's degree from the University of Virginia--University
    of Pennsylvania.
        Richard Ravitch is former Lieutenant Governor of the State
    of New York, which is one of many jobs he has held throughout
    his career. From `75 to `76, he assisted New York City and
    State officials in resolving New York City's crisis. He has an
    undergraduate degree from Columbia and a law degree from Yale.
        Welcome, and I thank all of you for being with us today,
    because we know it takes a lot of preparation. Your opening
    statements will be the same as other witnesses', 5 minutes.
    Longer statements will be put in the record, and we'll have a
    lot of questions, so I hope you'll stay to the time. We will
    start with Dr. Colon de Armas.
        I want to make an announcement. At 11:10, I have to be gone
    for a short period of time, and Senator Perdue will chair the
    hearing at that particular time. Would you proceed with your
    testimony.

             STATEMENT OF CARLOS A. COLON DE ARMAS, PH.D.,

                PROFESSOR OF FINANCE, GRADUATE SCHOOL OF

                  BUSINESS, UNIVERSITY OF PUERTO RICO,

                         SAN JUAN, PUERTO RICO

        Mr. Colon de Armas. Good morning, Chairman Grassley,
    Ranking Member Blumenthal, and Members of the Committee. Thank
    you for the opportunity to appear here today to discuss Puerto
    Rico's fiscal and economic challenges.
        My name is Carlos Colon de Armas. I am a professor of
    finance at the Graduate School of Business at the University of
    Puerto Rico. This document starts with an executive summary,
    that highlights the key points of my written testimony. Given
    the time constraints, I will limit my initial remarks to the
    executive summary, and I will leave the rest for the record and
    to discuss with you in the Q&A portion of the hearing.
        Puerto Rico faces two distinct challenges. A fiscal crisis
    and an economic crisis. Contrary to what most people are
    saying, the available evidence indicates that the fiscal crisis
    was not caused by a weakening economy. For one, the downward
    trend in the economy began almost three decades before the
    fiscal problems started. More importantly, public expenses
    started to get out of line at the same time that general fund
    revenues were increasing at a healthy pace.
        To finance its profligate ways, the government of Puerto
    Rico sacrificed its limited borrowing capacity that was
    supposed to be utilized only to finance public investments and
    used it instead to finance spending. As a result, an already
    fragile economy experienced a significant loss of investments
    and deteriorated even more.
        Fixing the economy of Puerto Rico, while necessary, will
    not repair the island's fiscal crisis. To fix the fiscal
    crisis, the government of Puerto Rico needs to cut spending. To
    fix the economic crisis, public and private investments on the
    island must be increased, and the business climate in Puerto
    Rico should be improved.
        The starting point to fix the fiscal crisis should be to
    cut expenses in the general fund by $1 to $1.5 billion. To be
    most effective, this reduction should be achieved through a
    participatory process that must include all relevant interest
    groups, including labor leaders. The evidence shows that this
    level of reduction in expenses is feasible, without the need to
    fire government employees, and without affecting the quality of
    the public services required by the citizens.
        The available evidence also demonstrates that the
    government of Puerto Rico has the necessary resources to honor
    its debt commitments as originally contracted. In other words,
    the public debt of Puerto Rico can be paid. Therefore, from the
    standpoint of what is best for Puerto Rico, default,
    bankruptcy, debt restructuring, or any kind of negotiation that
    involves not complying with debt commitments as originally
    contracted should be avoided at all costs.
        In this regard, the key consideration should be how to
    restore access to financial markets to enhance investments on
    the island. It would be incorrect to frame this issue as a
    short-term budgetary matter. To improve the quality of life on
    the island, more investments are needed. For those investments
    to take place, financing is necessary for which access to
    financial markets is essential.
        As an example, look at the recent drought in the San Juan
    metro area which left many residents without water for up to 5
    days a week, while water was going to waste on the western side
    of the island. This situation illustrates vividly the human
    costs of the government's inability to access financial markets
    to finance projects that are critical for everyday life in
    Puerto Rico.
        It also is important to mention that the government of
    Puerto Rico intends to force bond holders to suffer losses for
    problems caused not by the bonds but by unfunded loans issues
    by its own government development bank. Such an outcome, if
    implemented, would be unreasonable.
        To address many of these issues, appointing a control board
    has been proposed. I have mixed feelings toward that proposal.
    On the one hand, I recognize that a control board may be very
    effective to put the financial house in order and restore
    credibility in Puerto Rico. On the other hand, we do not need
    people to make hard decisions. We need people to make smart
    decisions. Yet these control boards have the tendency to enter
    troubled spots to cut indiscriminately. In Puerto Rico, this
    would not be the correct approach to follow.
        Perhaps instead of creating such a board, it could make
    more sense to establish specific targets of what needs to be
    done and to counter with an independent certified public
    accountant to certify whether it has been done. This approach
    would have the added benefit of keeping responsibility in the
    hands of the public officials whose job it is to fix these
    problems.
        The reality is that all the time that government officials
    are dedicating to measures like bankruptcy, debt restructuring,
    debt negotiations, and control boards diverts their attention
    from the important actions that they should be undertaking.
        Chairman Grassley. Can I ask you to summarize your
    statement?
        Mr. Colon de Armas. I am finishing.
        Chairman Grassley. Okay.
        Mr. Colon de Armas. It would be more productive if all that
    time and effort were dedicated instead to reducing public
    expenses. The rest is basically for the record.
        [The prepared statement of Mr. Colon de Armas appears as a
    submission for the record.]
        Chairman Grassley. Thank you. Mr. Spencer.

                    STATEMENT OF STEPHEN J. SPENCER,

               MANAGING DIRECTOR, FINANCIAL RESTRUCTURING

             GROUP, HOULIHAN LOKEY, MINNEAPOLIS, MINNESOTA

        Mr. Spencer. Chairman Grassley, Ranking Member Blumenthal,
    and Members of the Committee, my name is Stephen Spencer. I
    appear today for Franklin Advisers and OppenheimerFunds, who
    together own about $10 billion in Puerto Rican debt on behalf
    of more than a half million retail investors throughout the
    country.
        For 18 months, I have led negotiations between my clients--
    Franklin, Oppenheimer, and six other fund managers and the
    Puerto Rico Electric Power Authority, or PREPA. We got to a
    deal on significant debt relief to support PREPA's recovery,
    and I earned a deep understanding of Puerto Rico's problems in
    the process.
        Puerto Rico and its allies say access to Chapter 9 is an
    issue of fairness and a simple, effective fix. Nothing could be
    further from the truth. Giving Chapter 9 to Puerto Rico would
    impose a bailout on the backs of millions of retail investors,
    violate the sanctity of contract, undermine the rule of law and
    harm the Commonwealth and municipal debt markets throughout the
    country. More specifically, extending Chapter 9 would be poor
    public policy for three primary reasons.
        One, Chapter 9 would not allow Puerto Rico to fix its
    problems. Take Detroit. Presented as a success, but in reality
    a series of failures--a failure to address pensions, a failure
    to cut costs, a failure to streamline government. The court's
    own expert witness testified that the bankruptcy was largely
    focused on deleveraging the city, often to the exclusion of
    fixing the city's broken operations.
        This is the problem with Chapter 9. From Detroit and other
    recent Chapter 9 cases, like Vallejo, Stockton, and San
    Bernardino, the message to municipal officials is clear, pay
    bond holders as little as possible to avoid necessary reform as
    long as possible. Pensions that Vallejo and Detroit refused to
    address are already forcing Vallejo to contemplate a second
    Chapter 9 and threatening Detroit's recovery. Post bankruptcy,
    Detroit still needs help from the State of Michigan to issue
    debt. If Puerto Rico gets Chapter 9 today, it will be back to
    the Federal Government for help tomorrow, because like Detroit,
    no one will loan it money.
        The maturity of Puerto Rico's debt is held directly or
    indirectly--and this is the second point. Extending it Chapter
    9 will hurt individual retail investors in the broader muni
    market. The majority of Puerto Rico's debt is held directly or
    indirectly by individual retail investors, a largely mom-and-
    pop investor base, who buy municipal debt because it is safe.
    Congress told these retail investors they didn't have to worry
    about a Puerto Rican Chapter 9, so they bought Puerto Rico's
    bonds at lower interest rates. Over 30-plus years, the
    Commonwealth enjoyed billions in interest savings that these
    retail investors will never recover. That's the consequence of
    retroactively changing the rules and shows why so many
    individual investors would feel betrayed by Congress giving
    Puerto Rico access to Chapter 9.
        For the broader muni market, the Detroit experience
    suggests that extending Chapter 9 to Puerto Rico will be
    seriously disruptive. Post Detroit, yields on Chicago's debt
    increased 100 basis points, and they haven't returned to pre-
    Detroit levels. That cost Chicago $180 million in increased
    interest expense annually. And that is just Chicago. For the
    city of Scranton, the cost of borrowing doubled. Because Puerto
    Rico is nine times the size of Detroit, the impact of Chapter 9
    could be even more disruptive.
        Last, to support a long-term recovery, Puerto Rico needs to
    regain access to the municipal credit markets for long-term,
    low-cost financing. Chapter 9 will prevent this from happening.
        Third, Puerto Rico doesn't need Chapter 9 to recover. The
    Commonwealth says it can't pay its debts. That is a failure of
    political will more than statement of economic necessity.
    Puerto Rico has a comparatively low debt burden. Two years ago,
    the Commonwealth itself told investors that its debt load per
    capita is approximately 70 percent lower than any U.S. State.
    Puerto Rico can reduce costs. Puerto Rico's consolidated
    government expenditures have increased 47 percent over the past
    10 years, hardly austerity. And Puerto Rico, an island of 3.6
    million people, has 120 government agencies.
        Puerto Rico can reform its Tax Code. Puerto Ricans do not
    pay Federal income tax. They pay substantially less than U.S.
    taxpayers. Yet the Commonwealth still fails to collect over 40
    percent of its sales taxes and any income tax at all from many
    of its wealthiest residents. KPMG, the Commonwealth's own
    outside tax consultant, found that better tax collection and a
    simpler Tax Code would generate more than $3.6 billion a year.
    That's enough to close Puerto Rico's 5-year projected budget
    gap and leave a surplus of billions.
        I want to leave you with a few simple thoughts. Fix the
    Puerto Rico Tax Code, and you fix Puerto Rico. Fix Puerto
    Rico's government spending, and you fix Puerto Rico. Finally,
    give Puerto Rico Chapter 9, you fix nothing. You undermine the
    deal that we have cut with PREPA and the current negotiations
    toward a broader deal.
        Again, I thank you for your time, and I look forward to
    answering any questions from the Committee.
        [The prepared statement of Mr. Spencer appears as a
    submission for the record.]
        Chairman Grassley. Thank you, Mr. Spencer. Now, Mr.
    Pollock.

                     STATEMENT OF ALEX J. POLLOCK,

                  RESIDENT FELLOW, AMERICAN ENTERPRISE

                       INSTITUTE, WASHINGTON, DC

        Mr. Pollock. Thank you, Mr. Chairman and Senator Blumenthal
    and Members of the Committee. The government of Puerto Rico has
    run many years of constant budget deficits so that, as we all
    know, it now has a very large debt, which, according to its own
    statements, it cannot pay. It's cutoff from all normal bond
    market financing. The credit ratings of its many debt-issuing
    entities are at the bottom of the credit scale. It cannot
    produce timely, audited financial statements. Its public
    pension obligations are virtually unfunded, and an estimated
    $44 billion pension liability must be added to the $71 billion
    in government debt, giving us a total of $115 billion.
        It is my recommendation that the Congress should promptly
    create an Emergency Financial Control Board to assume oversight
    and control of the financial operations of the government of
    Puerto Rico, as Congress successfully did in 1995 with
    Washington, DC; as New York State, with Federal encouragement,
    successfully did with the insolvent and defaulting New York
    City in 1975; and as the State of Michigan did with the
    appointment of an Emergency Manager for the insolvent city of
    Detroit in 2013. Such control boards have also been used in
    Cleveland, Philadelphia, and Springfield, Massachusetts, and
    there is plenty of precedent.
        Of course, Congress has sovereignty over territories of the
    United States and the clear authority to create a control
    board. In my opinion, given the severe financial and
    management--or as the Chairman has said, mismanagement--
    problems, it also has the responsibility to create a control
    board in Puerto Rico, and in my view, this is the tool that's
    really needed.
        A control board is the first step to take. The initial
    requirement is to establish independent, credible authority
    over all books, records, and other information; to analyze what
    the true overall financial deficit is; to determine which
    Puerto Rican government bodies are insolvent, in particular to
    understand the financial condition of the Government
    Development Bank which lends to all the others; to consider
    fiscal, accounting, and structural reforms which will lead to
    future balanced budgets and control of debt levels; and to
    consider in the light of all of these how the current excessive
    levels of debt should be addressed. The control board, in my
    view, should be instructed to analyze and report to the
    Congress on whether creating a bankruptcy regime for Puerto
    Rico is warranted as a subsequent legislative action.
        The details of the Puerto Rican government's financial
    situation are complex, but the fundamentals are simple. The
    government of Puerto Rico is broke. In the current century, it
    has run a budget deficit every single year--that is 15 years in
    a row. Operating deficits have been financed by borrowing. And
    as debts multiplied, debt service was met by additional
    borrowing, utilizing debt issuance to pay interest on existing
    indebtedness. That is the definition of a Ponzi scheme, which
    must end painfully, as this one is now ending.
        Among the robust precedents for Emergency Financial Control
    Boards, the closest legal parallel is Washington, DC, which,
    like Puerto Rico, is not a State. The city had become a
    financial quagmire by the mid-1990s, and Congress, in a notable
    bipartisan effort, responded with the District of Columbia
    Financial Responsibility and Management Assistance Act of 1995,
    which the Chairman previously cited.
        Although there were disputes and difficulties along the
    way, the Washington D.C. Control Board achieved clear success
    in financial management and controls, efficiency, and reaching
    balanced budgets. It adjourned in 2001, but is authorized to
    return should Washington, DC's budget discipline ever again
    slide into aggregate deficits.
        Now, the cases of New York City and the city of Detroit are
    discussed in my written testimony, and I think all evidence
    indicates the time for a control board has come.
        Mr. Chairman, Puerto Rico's financial and managerial
    problems are severe, and as the Governor has already said, its
    cash is running out. In my judgment, Congress should establish
    the Emergency Finance--Financial Control Board for Puerto Rico
    as a high priority. Thank you for the chance to share these
    thoughts.
        [The prepared statement of Mr. Pollock appears as a
    submission for the record.]
        Chairman Grassley. Thank you, Mr. Pollock. Now, Mr.
    Carrion, proceed please.

                     STATEMENT OF RICHARD CARRION,

                   EXECUTIVE CHAIRMAN, BANCO POPULAR,

                         SAN JUAN, PUERTO RICO

        Mr. Carrion. Good morning, Chairman Grassley, Senator
    Blumenthal, and other distinguished Members of the Committee.
    My name is Richard Carrion. I am chairman and CEO of Popular,
    the holding company of Banco Popular de Puerto Rico. Banco
    Popular is the largest financial institution on the island, and
    our 122-year history has been closely linked to that of Puerto
    Rico's.
        While it is an honor to appear before you today, as a
    banker, or even more so as a proud Puerto Rican, I deeply
    regret that Puerto Rico's dire fiscal and economic situation is
    the topic which brings us to the attention of this Committee.
        After a decade of economic contraction, lack of fiscal
    discipline, and increasing public debt to unsustainable levels,
    Puerto Rico now stands at a critical junction. Leaders from
    several administrations and different political parties have
    opted to ignore structural problems and postpone difficult
    decisions because it was easier to keep borrowing to fund
    operational deficits and kick problems down the road.
        No amount of regret or even indignation will solve our
    problems. I am here today because I am convinced that without
    prompt, decisive, and coordinated action by local and Federal
    Government authorities, Puerto Rico's future is in jeopardy.
    Since time is limited and I previously submitted my written
    testimony to the Committee, I will stress two points that I
    feel are critical and will hopefully help you gain a deeper
    understanding of the Puerto Rico fiscal and economic situation
    and then answer any questions you may have.
        First, the Puerto Rico government will run out of money,
    and soon. In fact, the only reason why it hasn't done so
    already is because the government has employed several
    emergency liquidity measures such as delaying payment of income
    tax refunds owed to taxpayers, using part of the liquidity of
    the two largest retirement systems, and deferring payment of
    accounts payable to vendors and other third parties. These
    measures are clearly unsustainable, and they are harming the
    economy.
        The funds required to service the existing debt are
    substantial and increasing. In this fiscal year, the Puerto
    Rico government is scheduled to make $4.1 billion in debt
    payments, which represents approximately 40 percent of
    projected revenues. Given the lack of access to the capital
    markets, absent some type of restructuring, the government
    would have to pay the full principal and interest coming due,
    something it will be unable to do while it seeks to provide
    basic services to the population.
        Furthermore, the government's severely underfunded pension
    plan will place additional pressure on public finances. Once
    the funds are depleted, which is expected to happen soon, the
    central government will have to divert resources normally used
    to provide essential services to pay pension benefits.
        Finally, if no measures are taken to address the impending
    depletion of Medicaid funds, the government could be forced to
    incur additional expenses related to health care. While I am a
    very strong advocate of free thinking and restructuring the
    entire central government, there is simply no amount of cost
    cutting or belt tightening that will generate the funds to
    bridge this enormous financing gap.
        The second point, I am convinced that an effective, long-
    term solution for Puerto Rico's fiscal and economic troubles
    must include three components.
        First, we need a legal framework to restructure all of
    Puerto Rico's public debt in an orderly fashion. A successful
    debt restructuring requires a legal regime where the interests
    of all parties can be balanced fairly while allowing financing
    alternatives that would provide much needed liquidity during
    restructuring. The absence of such a regime will result in a
    slew of legal battles that will take years to resolve and
    create disruption and uncertainty while consuming inordinate
    resources and, inevitably, debt defaults.
        The second element is an effective fiscal oversight and
    control mechanism. Puerto Rico's current economic problems are
    closely tied to a decade of sluggish economic growth, but also
    are a direct result of longstanding fiscal undiscipline. The
    oversight body should consist of members with the appropriate
    expertise, must be truly independent, and it needs to have the
    necessary authority to effectively carry out its oversight and
    control responsibilities.
        Finally, an effective plan must include economic stimulus
    measures to incentivize new investment and promote employment.
        These three components are all necessary, and not one of
    them is sufficient by itself. The failure to include any one of
    those components would render the other two ineffective.
    Problems that took decades to create cannot be solved in months
    or through small or isolated efforts of one group or another. A
    real solution will require local and Federal action, support
    from the executive and legislative branches, backing from all
    political parties, and the active participation of all sectors
    of Puerto Rican society. Failure to take decisive action now
    will only make these problems worse and their solutions more
    costly and less effective. Thank you.
        [The prepared statement of Mr. Carrion appears as a
    submission for the record.]
        Chairman Grassley. Thank you very much. Now, Mr. Ravitch.

                  STATEMENT OF RICHARD RAVITCH, FORMER

                LIEUTENANT GOVERNOR, STATE OF NEW YORK,

                           NEW YORK, NEW YORK

        Mr. Ravitch. Thank you, Mr. Chairman, Senator Blumenthal,
    Members of the Committee. It is a privilege to be here. I
    represent no one in this matter. I am not compensated for the
    time I have spent in the last year examining the fiscal
    situation in Puerto Rico. I was, as the Chairman referred to
    it, very much involved in New York City's fiscal crisis in 1975
    as an adviser to Governor Carey. I sat in the halls of this
    Congress and the Treasury Department 40 years ago this past
    November addressing some of the same very basic issues. And
    I've been an adviser to the bankruptcy judge in Detroit, and I
    continue my involvement there at Governor Rick Snyder's request
    as an adviser to the control board in Detroit. And for the last
    5 years, my dear friend and colleague, former Fed Chairman Paul
    Volcker, and I have spent a great deal of our time and effort
    studying the fiscal stress that many cities and States are--are
    addressing within increasing alarm, with reduced expenditures
    in education and infrastructure, untenable pension obligations,
    and increasingly difficult burdens to open up credit markets
    for themselves.
        It is my conclusion that restructuring all of the debt--the
    general obligation debt, the Cofina debt, as well as the
    corporate and municipal debt--is the sine qua non of assuring
    social stability in Puerto Rico and giving Puerto Rico a chance
    to recover economically.
        I believe such restructuring authority is not
    constitutionally questionable since Article IV of the
    Constitution gives the Congress the power to make any rule
    whatsoever with respect to a territory.
        I know the concern that many people share, and
    legitimately, and I share it myself, as to whether or not this
    is an inappropriate precedent to the suggestion that States
    should be authorized to file bankruptcy. And I have to say
    though that position was very well advocated by Jeb Bush and
    Newt Gingrich in an article in the Los Angeles Times, I do not
    agree with it because of the simple fact that it is the 11th
    Amendment to the Constitution which says that a Federal court
    can't have jurisdiction over a dispute between one State and a
    citizen of another State. And that's the reason why States
    cannot file bankruptcy. So, I agree with--disagree with Mr.
    Bush and Mr. Gingrich on that matter.
        I think that the issue that many jurisdictions are
    struggling with around this country as to how do you deal with
    the fact that they have debt service obligations and pension
    obligations that they can't meet, and whether it's political
    decisions or court decisions, I think basically the principle
    that is emerging that is governing these decisions is that a
    promise to pay interest to somebody is morally--lends you money
    is morally indistinguishable from a promise to pay a benefit to
    somebody who worked for you for 20 years. And Puerto Rico faces
    a particularly severe problem because, inappropriately and
    improperly, they have spent down their pension fund, and in
    another 12 to 18 months, they are obligated, in the absence of
    any authorization to renegotiate these benefits, they are
    obligated to pay a billion two hundred dollars a year in
    pension benefits to close to 100,000 retirees. That is
    potentially a very, very serious problem.
        Richard Carrion mentioned that the debt service obligations
    are equal to 40 percent of the revenues of the Commonwealth.
    Well, the average percent of revenues that are utilized to pay
    debt service in every other jurisdiction in this country is
    somewhere in the neighborhood of 5 to 6 percent.
        If the debt--total debt service obligation of the
    Commonwealth and its corporations is not significantly reduced
    in the short term, there will be insufficient cash to provide
    for the basic essential services of running the government.
        If I may, Mr. Chairman, quote from a Wall Street Journal
    editorial, quote, ``Bankruptcy would be painful and carries
    risks, but an orderly restructuring under a legal framework in
    Federal court is preferable to a creditor brawl that would
    likely follow-up in default. Hedge funds, mutual funds, and
    bond insurers would have to take haircuts for mispricing the
    risk in enabling Puerto Rico's political mismanagement.''
        Incredibly, yields on the island's general obligation bonds
    were as low as 6 percent 2 years ago. As of last July, they
    were yielding 12 percent.
        Let me say, Mr. Chairman, that the issue of--of
    restructuring debt is a serious center issue to the future of
    this island and its population. I have to add that I think a
    concomitant of such an authorization has to be a federally
    mandated oversight board. And with all respect to Mr. Pollock,
    the New York Board, which I helped design back in 1975, did not
    have the powers that were legislated for the District of
    Columbia. And nor does the Detroit Control Board have those
    powers. Such an oversight board should merely have the power to
    approve budgets, to approve any future incurrence of debt, and
    to approve any colleague bargaining agreement. And it should
    have the right to approve any restructuring plan that the
    elected government of Puerto Rico comes up with.
        Let me say, last of all, that I think to permit a filing of
    only the corporations would produce several unintended
    consequences that are not in the public interest. One, if that
    were to be enacted, it would increase by billions of dollars
    the----
        Senator Perdue [presiding]. I am sorry to interrupt. Can
    you move to a close for us?
        Mr. Ravitch. Sure.
        Senator Perdue. Thank you.
        Mr. Ravitch. It would increase the value of the general
    obligation debt automatically by billions of dollars. It would
    prevent the Commonwealth from being able to do debtor in
    possession financing. And, last of all, Mr. Chairman, if I may,
    the suggestion that we need a Federal control board now, the
    Federal Reserve Bank of New York has had a very talented group
    of people studying the economy. I don't know to what extent
    their research is made public. And the U.S. Treasury Department
    has been studying it, a large group of very talented people.
    I'm not sure that anybody else could come to a different
    conclusion than the Treasury Department and the Federal Reserve
    Bank came to in concluding that debt restructuring was
    essential for the future of Puerto Rico.
        Thank you, Mr. Chairman.
        [The prepared statement of Mr. Ravitch appears as a
    submission for the record.]
        Senator Perdue. Thank you, and thank you to the panel
    today. We will start questioning, in the absence of Chairman
    Grassley, with Senator Hatch.
        Senator Hatch. Well, thank you, Mr. Chairman. I have been
    very interested in each one of you and your testimony here.
        Senator Perdue. Your microphone.
        Senator Hatch. I do have it on. I just better move up a
    little bit maybe.
        Senator Perdue. A little closer.
        Senator Hatch. Okay. I will try. Let me ask this question
    of Mr. Colon de Armas and Mr. Pollock. I would like to begin by
    asking some questions about Chapter 9, and my first question is
    this. How much would extending Chapter 9 to Puerto Rico
    actually improve the situation on the island? Would it reach
    enough debt to make a significant difference? And what about
    the approximately 70 percent of island debt that Chapter 9
    would not reach? If you could take a crack at that, Mr. Colon
    de Armas and Mr. Pollock.
        Mr. Pollock. Thank you, Senator. The--Chapter 9 for
    municipal entities would not reach a lot of the Commonwealth
    debt. There's another proposal to have the Commonwealth of
    Puerto Rico itself be able to enter into Chapter 9, a more
    radical or fundamental idea. In my opinion, as I said, the
    first step is the control board to clarify the situation.
        Mr. Ravitch, maybe we could put a couple members from the
    Treasury and the Federal Reserve Board on that control board as
    they get around to approving the plans of the government of
    Puerto Rico and potentially being able to give instructions to
    it.
        In a banking situation, you don't first put the bank in
    receivership. You first send in an examination team to find out
    what the situation really is, give such instructions as you
    think can save the situation with the least cost to all
    concerned. And it seems to me that's a fair model for the
    situation we have with the very troubled and messed up finances
    of Puerto Rico.
        Mr. Ravitch. If I could add, Mr. Chairman, very quickly,
    the firm of Conway MacKenzie was retained some time ago to do
    an independent liquidity study of the financial situation. They
    have issued 2 such reports. And about a year ago, the
    Commonwealth, at the urging of some of its counselors, retained
    a very reputable economist, Anne Krueger, from the IMF, to do a
    study, and she produced a very exhaustive, thorough study which
    concluded that the Commonwealth was incapable of meeting its
    obligations at anywhere close to its current level of revenues.
    That report is fully available publicly and I think was
    released last June.
        Senator Hatch. We will look at that. Mr. Colon de Armas.
        Mr. Colon de Armas. Senator, my main concern regarding
    bankruptcy is what sustains that proposal, and to sustain that
    proposal, people use the figure of 40 percent debt burden.
    Well, let me share--share with you some facts.
        The general fund budget for this year in Puerto Rico, as
    approved by the legislature and signed by the Governor, has the
    proper debt service payments, and those debt service payments
    represent 15.8 percent of the budget. On a consolidated basis,
    for the entire government, the debt service burden represents
    16.8 percent of the budget. Those are the official numbers.
    Those are the correct numbers.
        Now, the 40-percent figure appears on page 17 of the
    Working Group report that itself is based on the Krueger
    report. Now, to reach 40 percent, they selected by their own
    free will--there is no basis that I know of--they selected
    particular agencies to include. They did not include revenues
    from the new increased sales tax. They did not include revenue
    from the VAT tax that was approved. And from the selected
    agencies that they chose to put together in the calculation,
    from that group and the revenues they selected to use, they
    proved allegedly that the debt burden is 40 percent.
        I want to point out for the Committee that the Krueger
    report, as stated in the disclaimers, was not prepared at the
    request of the government. It was prepared at the request of
    counsel. It may be a good document to support a particular
    legal strategy. I have big reservations as to whether that
    report really serves as the basis for sound public policy.
        Senator Hatch. Well, Mr. Chairman, if I could just ask one
    more question, I am very concerned about these issues. We know
    we have got to solve these problems, and I want to do it in the
    best possible way. But let me just ask this question. Let's
    talk about retroactivity. We have heard arguments that
    extending Chapter 9 to Puerto Rico would be unfair to bond
    holders because it would reduce their return on their
    investments. Now, some have argued that any Chapter 9 extension
    should apply only to future debts.
        As an initial matter, it would be helpful to know whether
    past Bankruptcy Code reforms have applied to existing debts or
    whether bankruptcy reforms have typically applied only to
    future debts. Can any of you offer any insight on this matter?
    And if past reforms have applied to existing debts, have any of
    those reforms been analogous to what we are considering here,
    namely, extension of bankruptcy access to entities which
    previously had no such access? Anybody care to take that?
        Mr. Spencer. Senator Hatch, I will take it. This is a
    fundamental investor protection issue. Puerto Rican investors,
    retail investors, bought this debt with the explicit--with the
    knowledge that Puerto Rico was explicitly precluded from filing
    for Chapter 9 protection. There is a lot of question about the
    intentions behind precluding Puerto Rico from Chapter 9. To me
    it is very clear. There was a--an investor protection issue
    that went along with a unique benefit that was given to Puerto
    Rico. Puerto Rico Congress gave Puerto Rico the unique benefit
    of being able to issue debt tax-free in every State in the
    Union. But they gave an important protection to these
    investors, the retail investors, in that debt in the form of
    preventing Chapter 9 from--preventing Puerto Rico, rather, from
    using Chapter 9. You can't separate the protection from the
    benefit. Those two go hand in hand, and that would be pulling
    the rug out from underneath retail investors throughout the
    country.
        Senator Hatch. I understand. Now, look, there has been a
    lot of discussion in Congress both about Chapter 9 and about
    the possibility of creating a financial control board for the
    island, which has been mentioned here. Are there any other
    ideas or proposals that Congress should be looking at to
    address Puerto Rico's financial crisis? Because I am happy to
    look at anything to help this.
        Mr. Ravitch. Might I, Mr. Chairman, just comment further on
    Senator Hatch's first question, and that is, there are--have
    been many instances since--bankruptcy by a municipality is not
    permitted unless a State specifically statutorily authorizes
    it. So, there have been the instances in which municipalities
    have filed have come after States have--in some cases
    subsequent to States having authorized it.
        When Governor Snyder appointed an emergency manager, not to
    be the equivalent of a bankruptcy judge but merely to assume
    the fiscal powers of the city incident to submitting to a
    bankruptcy court a plan of adjustment, that is very different
    from what had been otherwise described here. And, second of
    all, that the buyers of over $3 billion of general obligation
    debt in the spring of 2014 at a stated return of in excess of 9
    percent a year interest rate, which is over 3 times higher than
    what any government that is run prudently has to pay in
    interest costs to run its operation--look, if I may, at the
    prudent way that the State of Utah budgets, they do not pay 9
    percent; they pay less than 3 percent for their money.
        And, furthermore, the simple fact is that the amount of
    money that was lent in 2014, Senator Hatch, was lent without
    the benefit of having received an audited financial statement
    from the year 2000, FY 2013. So, the creditors who now assert
    that they should not run the risk of a restructuring authorized
    by the Federal Government, nonetheless, without any audited
    financial statements, lent, as I said, $3 billion at over 9
    percent.
        Mr. Colon de Armas. Senator, if I may----
        Senator Hatch. Thank you. I am sorry I took so long.
        Mr. Colon de Armas. If I may?
        Senator Perdue. Yes, briefly. Go ahead.
        Mr. Colon de Armas. Senator Hatch asked for what Congress
    could do to solve this situation. I think the most important
    issue is to abandon the myth about Puerto Rico and look at the
    facts. Take, for instance, the tax-related proposals. Puerto
    Rico is not part of the U.S. Tax Federal system, so you need to
    be careful. Many of the proposals being toyed around with are
    not going to help Puerto Rico, EITC and all those. But the
    benefit to Puerto Rico from those proposals is limited because
    we are not integrated into the tax system.
        What Puerto Rico needs in terms of economics is more
    investments. We need to improve our water storage and
    distribution system. We need to improve our energy generation
    capacity. We need to improve our transportation infrastructure.
    We need to improve the business climate on the island. If I
    wanted to work on what is best for the economy of Puerto Rico,
    those are the areas that I would target. Health-related funds
    are important, and it is a fairness issue. Many of the issues
    that are discussed are issues that are not really economic in
    nature. They are issues that are camouflaged as economic
    arguments but are really political in the end. So, solving the
    status could also be helpful in eliminating those discussions.
        Senator Hatch. Well, thank you.
        Mr. Pollock. Senator Hatch, may I answer your question
    about are there other possibilities? There is one other
    possibility, of course, and that's a bailout. You just give
    troubled debtors more money, and in these situations, you can
    either restructure debt under some form of governance. You can
    restructure the government, the budgets, the control, the
    financial management. And you can provide money. And I think
    the comment that it is a political discussion is quite true. It
    is what is the governance under which these decisions are being
    made, and in my view, as you know, of course, the control board
    is the superior governance mechanism.
        Senator Perdue. Thank you. Senator Blumenthal.
        Senator Blumenthal. Thank you. Let me pursue the thought
    that you just raised, Mr. Pollock. I think all of the witnesses
    here agree that the current story ends well for no one. The
    status quo is unacceptable. The current situation is
    unsustainable. You are very direct in saying that Puerto Rico
    is broke. That is the classic definition of insolvency. So, I
    take it you would disagree with Mr. Spencer that--that the
    Commonwealth can continue paying its debts--I know that I am
    summarizing his testimony--continue paying its debts by taking
    the measures that he suggests.
        Mr. Pollock. Thanks, Senator, and may I start by saying
    thank you for quoting Pollock's Law of Finance in your opening
    statement, that loans which can't be paid won't be paid. The
    question is, which loans are those of the many debtors? To what
    extent can't they be paid or can they be paid? I don't think we
    know the answers to those yet, and I think we ought to put
    ourselves in the--in the position to know it.
        The government--my precise statement was the government of
    Puerto Rico is broke, and I think it's true that under its
    current operations, with its current management, it can't pay
    its debts. It is an open question yet whether with serious
    reforms and improvements in discipline and management that
    couldn't be much improved.
        Senator Blumenthal. And, in fact, Mr. Spencer, as you know
    from your experience with bankruptcy court, the first judgment
    that a bankruptcy court has to make is, in fact, whether the
    petitioner is insolvent. In fact, I tried a bankruptcy case in
    which the city of Bridgeport sought Chapter 9 protection and
    was denied it. The State, which I represented, in fact, opposed
    the bankruptcy filing, and the bankruptcy court denied it after
    a trial in which it concluded that the city of Bridgeport, in
    fact, was not insolvent.
        So, if your concern is legitimate factually, why can't the
    bankruptcy court simply make that determination?
        Mr. Spencer. You are correct that the bankruptcy court
    makes a fundamental determination----
        Senator Blumenthal. And so, why not give Puerto Rico the
    opportunity to have access to the bankruptcy court that could
    make that determination and, in fact, consider the interests of
    the investors whom you represent as well as the obligor, the
    Commonwealth of Puerto Rico?
        Mr. Spencer. Senator, because I have a fundamental problem
    with Chapter 9. There is a perception that Chapter 9 is very
    similar to Chapter 11, that is a fair and equitable forum for
    dispute resolution. It's not. Chapter 9 fundamentally gutted
    protections, important creditor protections. Everything that
    Chapter 11 does so well, balancing the interests of debts and
    creditors, Chapter 9 got horribly wrong. And that is the
    reason----
        Senator Blumenthal. Well, you may have----
        Mr. Spencer [continuing]. It is not a fix for Puerto Rico.
        Senator Blumenthal. And I apologize for interrupting you,
    but under our rules my time is limited, so I am trying to
    elicit as much testimony as I can. And I understand your
    criticism is of Chapter 9 generally. But if we're going to
    extend Chapter 9 for public policy reasons to municipalities
    generally, isn't there an argument based on consistency that we
    also give municipalities and governmental entities in Puerto
    Rico the same kind of access that other municipalities have?
        Mr. Spencer. Well, again, Senator, Puerto Rico was
    explicitly precluded, and it's not a State, and more
    fundamentally to bankruptcy, Chapter 9 solves nothing. It hurts
    retail investors throughout the country, and, importantly, it
    keeps Puerto Rico on a path to an eventual Federal bailout.
        Senator Blumenthal. Let me turn, in the time that I have
    left, to Mr. Ravitch. You made the point, and I think it's a
    valid one, that under our Constitution, States are precluded
    from, in effect, access to bankruptcy protections such as
    Chapter 9. I take it that argument would not apply to a
    territory. Is that correct?
        Mr. Ravitch. As I testified, because of Article IV of the
    Constitution, yes, sir.
        Senator Blumenthal. And so, a territory like Puerto Rico
    would not be precluded by the Constitution from----
        Mr. Ravitch. That is correct. And I don't think there is
    any disagreement. I know the scholarship that is published on
    this subject. I don't think there is any disagreement with
    that.
        Let me say, if I may, Senator, in response to what Mr.
    Spencer said, number one, the people who worked for the Puerto
    Rican government and expected that their promise to receive a
    benefit on their retirement in their old age also perhaps
    relied on the fact that there would not be a bankruptcy
    authorization. It's not just--there's not only one kind of
    obligee, the people who want cash. And, second of all, with all
    respect again, the interest rate in Chicago did not go up
    because of Detroit. It went up because the State in its wisdom
    decided to reduce its income tax revenues by 40 percent in an
    effort by the mayor to get--a modification of pension benefits
    failed in the highest court of Illinois. And, therefore, with
    $100 billion underfunding of its pension system, its credit
    rating went way down. That's why Chicago's interest rate went
    way up.
        Senator Blumenthal. Mr. Chairman, I would just like to ask
    that the testimony of Mark Zandi be entered in the record. It
    is written testimony. And he points out, by the way, that in
    the last 13 years--in other words, since 2003--the public--
    number of public employees, State and local, has been cut by 25
    percent. I think that kind of cut over a little more than a
    decade is unprecedented. Mr. Carrion has pointed out that
    hundreds of thousands, I believe, have been cut just in the
    last 2 or 3 years. So, these cuts are ongoing. They have been
    made. Thank you.
        Senator Perdue. It will be added, without objection.
        [The prepared statement of Mark Zandi appears as a
    submission for the record.]
        Senator Perdue. Senator Lee.
        Mr. Colon de Armas. Mr. Chairman, may I address the issues
    that Mr. Blumenthal raised?
        Senator Perdue. Certainly.
        Mr. Colon de Armas. Mr. Blumenthal asked a question about
    couldn't bankruptcy court make the determination of insolvency,
    but that is a statement made from the perspective of a
    budgetary problem and the point of view of bond holders.
        From the point of view of Puerto Rico and what is best for
    Puerto Rico, just petitioning to bankruptcy court, we lose. And
    the important thing from Puerto Rico's standpoint is restore
    access to financial markets. If we get to bankruptcy, even if
    we simply file, we are not helping Puerto Rico at all.
        Senator Blumenthal. The only point I would make, sir, if I
    may, with all due respect, Puerto Rico has already, in effect,
    petitioned for bankruptcy by seeking officially and publicly
    that it be given the opportunity to do so, leaving no doubt
    that it would if it had that legal authority. So, I understand
    your point, but I think that that horse is out of the barn.
        Mr. Colon de Armas. Well, but if I may, we have an economic
    crisis and a fiscal crisis. The liquidity crisis that is also
    mentioned has nothing to do with the fiscal and economic
    crisis. The liquidity crisis is a self-inflicted problem
    because of exactly what you mentioned. Because Puerto Rico is
    petitioning for the right to go to bankruptcy court, because
    Puerto Rico is finding ways of not complying with its debt
    commitments, we have been closed from the financial markets,
    and that is the liquidity issue that is self-inflicted.
        Senator Perdue. Thank you. Senator Lee.
        Senator Lee. Thank you, Mr. Chairman. Thanks to all of you
    for being here.
        Mr. Spencer, I would like to start with you, if I could.
    Talk to me about what you think about the possible
    constitutional impediments to Congress extending the
    availability of Chapter 9 background to States. What
    constitutional impediments would there be to that type of
    action?
        Mr. Spencer. First of all, let me preface my remarks by
    acknowledging I'm not a constitutional scholar or even a
    lawyer. I--I approach this from the perspective of a
    practitioner, so my--my issue with Congress extending Chapter 9
    to Puerto Rico is not rooted really in constitutional law
    issues.
        My issue with extending Chapter 9 is two-fold. One, it's
    not a fix for Puerto Rico; and, two, as you have heard, I have
    fundamental issues with Chapter 9 as a statute. What--in my
    practical experience in municipal restructuring, Congress erred
    when it gutted--when it passed Chapter 9, a law that gutted
    fundamental investor protections. That introduces a tremendous
    moral hazard for municipalities that want to use it.
        So, I don't know if I answered your question, but those are
    my principal concerns.
        Senator Lee. I appreciate that. That's helpful insight. Mr.
    Ravitch, why don't you chime in and answer the same question?
    What constitutional impediments do you see that would exist?
        Mr. Ravitch. The 11th Amendment to the Constitution, which
    says a Federal court can't have jurisdiction over a dispute
    between a citizen of one State and another State, and that, by
    definition, would be if a State were able to file, some of the
    creditors would be from other States. And that's why legal
    opinion has always said States can't file, despite, as I said,
    the arguments that have been made by Jeb Bush and--and if you
    would care to have a copy of it, I happen to have it with me
    and would be glad to share it with you.
        Senator Lee. It is the 11th Amendment. It is all the 11th
    Amendment. There is not----
        Mr. Ravitch. Yes, sir.
        Senator Lee. Okay. Thank you. Mr. Colon de Armas, you
    referred to 2 things that you state are necessary steps to take
    to revitalize Puerto Rico's economy. One involves government
    cutting spending, and another involves increasing investments,
    public and private, in Puerto Rico. In your opinion, how would
    extending Chapter 9, either little Chapter 9 or Super Chapter
    9, to Puerto Rico affect those essential elements of economic
    recovery in Puerto Rico?
        Mr. Colon de Armas. Well, I alluded to in my testimony to
    the situation in the water crisis. That was the best example
    that I can think of. We have excess water in Puerto Rico, but
    it is not well distributed.
        Senator Lee. On the west side of the island.
        Mr. Colon de Armas. Right. In the middle of this fiscal
    crisis, we had a drought situation in the metro area. Some
    areas had limited service of water for 5 days a week. And in
    the middle of all this, the Puerto Rico Aqueduct and Sewer
    Authority, which has the finances to go to bonds, to the bonds
    market, was working on a bond issue, because the government
    filed a brief to the Supreme Court defending the bankruptcy
    local law. They had to cancel the projects. They had to cancel
    the bond issue. And the solution to the water crisis was solved
    with rain in this day and age. We couldn't make the investment
    in infrastructure. We couldn't solve one of the most essential
    services for people--water--because the strategy selected by
    the government of Puerto Rico closed access to financial
    markets.
        Bankruptcy, to answer your question directly, would deter
    Puerto Rico from financing, and if you deter Puerto Rico from
    financing, you are not able to make investments.
        Senator Lee. I would imagine, by the way, that those most
    affected by that 5-day water crisis were not the wealthy. Those
    most affected were likely----
        Mr. Colon de Armas. I feel it was the whole metro area. It
    was widespread.
        Senator Lee. Well, thank you. That is helpful. Would--I
    will extend this question both to you, sir, and also to Mr.
    Spencer, whoever wants to answer it. Would extending any
    iteration of Chapter 9 to Puerto Rico, if you were to do that,
    what impact would it likely have on the negotiations between
    bond holders and major public corporations such as PREPA?
        Mr. Spencer. I'll start. I think the agreement, the--the
    restructuring support agreement that we were able to reach in
    PREPA, happened precisely because Puerto Rico did not have
    access to Chapter 9. Had it had access to Chapter 9, we would
    not have reached that accord. I believe that if it is extended
    now, not only will it jeopardize the--there are many execution
    steps left that the deal will not close until sometime Q2 this
    next year. I believe it will jeopardize concluding and closing
    that deal. And I believe it will jeopardize the negotiations
    that are already ongoing between a substantial component of the
    island's major investors and the island itself.
        If the island is negotiating in good faith with us, right
    now we will continue to negotiate in good faith with it, and I
    have every confidence that that will yield a constructive
    result for the island.
        Mr. Ravitch. Senator, may I respond briefly to that? The
    filing of bankruptcy would produce an orderly negotiation and
    discussion as to how to settle the fact that the Commonwealth
    doesn't have the ability to pay all its debts. The absence of a
    bankruptcy authorization wouldn't mean that the debts would be
    paid. It would mean that there would be endless acrimonious
    litigation in the courts in New York and in Puerto Rico with a
    resolution that during which the liquidity problem of the
    Commonwealth would face would be overwhelming. And in New
    York's case, a matter, hopefully, of interest to you, it was
    the power to file bankruptcy that gave us the ability to
    leverage our negotiations with both the unions and the banks.
    But we, nonetheless, had a liquidity crisis, which is why a
    month after President Ford had announced that the Federal
    Government was not going to help New York, the choice was if we
    filed bankruptcy, we could get debtor in possession financing.
    And it was the view of the financial world that even the mere
    filing, regardless of what the consequence, would injure New
    York as the financial center of the world. It was at that point
    that Secretary Simon decided that the Federal Government would
    provide that liquidity with a fully secured program under which
    the Federal Government was guaranteed of repayment. So, that
    was because the only way you could get the other financing was
    by filing.
        Mr. Spencer. Senator, I would like to respond to that just
    briefly. With respect to Mr. Ravitch, I advised the single
    largest creditor in the city of Detroit's bankruptcy. Detroit
    wasn't a bankruptcy. It was a stick-up. And--because there
    were, again, fundamental creditor protections that are absent
    in Chapter 9. And, again, with respect to Mr. Ravitch, New
    York, DC, other cities have all done this outside of Chapter 9.
    I understand that threat. The markets understand that threat.
    But it is a threat that is counterproductive from the
    standpoint of long-term sustainable fiscal recovery for the
    island.
        Mr. Colon de Armas. If I may----
        Senator Perdue. Mr. Carrion.
        Mr. Carrion. I just want to interrupt, and I am sorry. I am
    a banker. I like people to pay their debts. What I say I don't
    say lightly. But let us bear in mind that the money will run
    out. And I think that is the key point I wanted to make. The
    money will run out. I am all for trying to do voluntary
    restructurings. There is just not enough time. The money will
    run out. The debt will start not getting paid, and there needs
    to be the three things that I mentioned. There needs to be some
    regime, some forum to balance the interests of all the affected
    stakeholders. There needs to be some kind of fiscal oversight
    board. And there needs to be--above all, there needs to be
    stimulus to the economy.
        Senator Perdue. Professor, I will come back to you. I still
    have reserved my time, so I will give you a chance during my
    time. But I want to honor Senator Durbin. You have been very
    patient here, Senator Durbin.
        Senator Durbin. Thank you very much, and thanks for your
    testimony today. I want to acknowledge that I'm receiving
    counsel on this from Luis Gutierrez of Chicago, as well as
    Nydia Velasquez I see in the audience here, my former colleague
    from the House, and Jose Serrano, who I also notice is here.
    And I apologize if I've met others, but we are in constant
    communication about this situation.
        I'm trying to put this in a broader perspective, and we
    start with the premise that our relationship with the island of
    Puerto Rico is unique. We do not have anything quite like that
    anywhere else in the world, and we have a special relationship
    with Puerto Rico and the people who live there and many who
    come to the United States and become citizens and full
    participants in our political process. And I am trying to find
    some way to balance that political reality, that unique
    political reality, with the challenges that we face today.
        People have talked about what are the options. One option
    that someone mentioned is bailout. What if we just came in
    there and rescued Puerto Rico? I don't think that is going to
    happen. I have to tell you, as I listened to the budgetary
    debate here in Congress, I don't think there is an appetite for
    that. And versions of it, including reimbursement for Medicaid,
    Medicare, EITC, are a form of helping Puerto Rico get on its
    feet, but it will be, in fact, a painful process here on
    Capitol Hill.
        There are others who argue that we should--I think the
    Governor said the reality, and reflected by Mr. Carrion, is
    that if we go to default, we go into depression, and things
    will get progressively worse. We do not want that to occur.
        When I look at Mr. Colon de Armas' argument, the Wall
    Street Journal argument, that it really isn't as bad as it
    appears, that it is only 17 or 18 percent, and a little belt
    tightening and we can see our way through this, Moody's does
    not agree with you on that, and I do not know that they have
    any particular special personal interest. They do have a
    reputation for a lot of people who follow their ratings as to
    whether they are being honest, and they have said flat out it
    is 40 percent in a publication which we have here. So, they
    kind of dispute your premise about 18 percent as they get into
    it.
        As I see it, that austerity, which is being preached by
    those who say it's not as bad as you think, is going to create,
    we know, further exodus from the island. People are going to
    leave if they can't, in fact, survive, if there are not jobs,
    if there are not basics in terms of essential services.
        Then there's this issue of the control board, and I have
    heard Mr. Pollock and Mr. Ravitch and others talk about this
    control board and our experiences with it in the past. And I
    think what you've said, Mr. Pollock, is control boards
    sometimes lead to bankruptcy--Detroit--sometimes don't lead to
    bankruptcy--Washington, New York City. So, it could happen; it
    might not happen.
        I would go to Mr. Carrion because I have listened to you
    carefully, and I understand, as you said earlier, as a banker
    it is painful for you to stand here--sit here and give us
    advice about not paying debts. But do you see this combination
    of control board and recommendation, yes-no, on a bankruptcy
    regime as a potential avenue?
        Mr. Carrion. Again, Senator, it is truly painful to sit
    here because I am ashamed that we have let it go this far. This
    is the product of many, many decades of mismanagement. I will
    tell you that a control board is necessary but not sufficient
    to solve the problem. I think we need to have some kind of
    regime to balance all these different interests. The pension
    issue has not come to the fore yet, but it will. The funds will
    run out in the next 18 to 24 months. And ultimately there needs
    to be some stimulus.
        So, it is a three-legged stool, if you will, that all three
    things are needed--not two, not one of them by itself.
        Senator Durbin. By three, you mean control board----
        Mr. Carrion. Control board, some kind of bankruptcy
    regime----
        Senator Durbin. Chapter 9.
        Mr. Carrion [continuing]. And economic stimulus.
        Senator Durbin. Economic stimulus.
        Mr. Carrion. Yes.
        Senator Durbin. There are some who have expressed concern
    that if there is not a bar or prohibition on subsequent filings
    under Chapter 9, the island, the nation, Puerto Rico----
        Mr. Carrion. I would hope we would never be in this
    position again. I would have no problem with a bar on
    subsequent filings.
        Senator Durbin. Mr. Spencer, you represent the bond holders
    who have a lot at stake here, and if you knew that there was a
    prospect of this outcome, control board and potential Chapter 9
    filing, do you feel there would be an effort underway by the
    bond holders to negotiate a better ending?
        Mr. Spencer. Again, I am somewhat ambivalent or maybe even
    a little conflicted on the issue of control board. There're two
    central issues in any control board. One is the composition of
    the board, and the second is the scope of powers. I don't know
    what is being proposed here, so I guess I would have to reserve
    judgment until I know exactly what is being proposed.
        But further to your prior question, Senator Durbin, I
    wanted to address in case there is a perception that we don't
    think the economic situation is serious. That's not true. We do
    understand. That's one of the reasons that motivated the
    constituents I represent to provide meaningful debt service
    relief to PREPA.
        The question, I think, though, is, does making Puerto Rico
    a financial pariah, which will most assuredly happen if they
    get Chapter 9 and they use it, does that help in terms of the
    long-term recovery interests of the island? I would point you
    again to Detroit. The premise there was if they purged
    significant debt obligations, the city on a post-reorganized
    basis would return to the capital markets and be able to borrow
    on a regular basis. I agree with Mr. Colon de Armas that one of
    the things that is needed--and really other members of the
    panel here--is investment capital to stimulate a recovery on
    the island.
        Senator Durbin. Mr. Spencer, let me ask, you use the word
    ``pariah.''
        Mr. Spencer. Yes.
        Senator Durbin. And you use ``bankruptcy pariah.'' Wouldn't
    you also be able to say ``default pariah?''
        Mr. Spencer. Exhibit A, Argentina. We do not want Puerto
    Rico to be the Argentina of the Caribbean. I don't think it
    needs to happen, and I don't think it is productive from a
    long-term recovery standpoint.
        Senator Durbin. Well, I think the situations are different,
    substantially different.
        Mr. Spencer. Admittedly.
        Senator Durbin. And I think Puerto Rico is in a weakened
    state--economic state and has been for a number of years, and I
    am trying to figure out a way to move, as Mr. Carrion and
    others are, to move us to a point where there is at least
    stability so people want to stay and invest their lives in the
    future of Puerto Rico. That to me has to be an ultimate goal
    for the good of that nation and our relationship.
        Mr. Spencer. One of the overlooked ironies of municipal
    bankruptcy is that the long-term recovery interests of the bond
    holders are very closely linked to the residents of any
    municipality, including the island of Puerto Rico. We need to
    see that happen as well, and we are looking for ways to make it
    happen.
        Senator Durbin. Thank you.
        Mr. Ravitch. Senator, may I, a fast observation on this?
        Senator Durbin. If the Chairman allows it.
        Senator Perdue. Absolutely. Go ahead.
        Mr. Ravitch. First of all, the control board did not come
    into effect until after the plan of adjustment had been
    approved by the bankruptcy court in Detroit. So, the control
    board didn't exist beforehand. What was created under Michigan
    law was a special provision to entitle the Governor to appoint
    an emergency manager because the government of Detroit was not
    deemed to be capable on its own hook of coming up with a plan
    to adjust.
        Second of all, it wasn't just the bond holders whose debt
    was cut back. The health care liabilities to the employees of
    the city of Detroit were cut by billions of dollars in the
    bankruptcy, and the pension was saved only because of an
    extraordinary exercise by the business community in Michigan,
    which contributed $400 million, and at the Governor's request,
    the legislature appropriated another $400 million. And that was
    the basis on which the pension--the retirees got money, and
    there were 23,000 of them, and they weren't even eligible for
    Social Security because the State of Michigan had waived Social
    Security. So, I think an examination of the Detroit bankruptcy
    would--would certainly--and Governor Snyder I think would have
    a very different view of it than Mr. Spencer.
        But I would only say that I think with all respect that the
    choice that Congress has here is a default with years of
    litigation--as I said, just because you can't file bankruptcy
    doesn't mean you are going to pay your debts. And the Governor
    made it very clear in June when he made public the assertion
    that they did not have the capacity to pay their debts.
        So, the question is whether it is done in an orderly
    fashion under the jurisdiction of a Federal judge and a
    bankruptcy process with all the requirements that that entails,
    constitutionally and statutorily, or whether it is done, as I
    said earlier, chaotically without any structure at all.
        Mr. Colon de Armas. Mr. Chairman, if I may, there was a
    comment made about something I said earlier, and I wanted to
    clarify.
        Senator Perdue. Please, go ahead.
        Mr. Colon de Armas. Senator, you pointed to the Moody's
    report, which I have right here with me. As I mentioned earlier
    in my testimony, Footnote 3 of that document, the reference
    that they used is a Working Group report. And I explained to
    you how that Working Group report is based on selective
    information at best.
        Now, I am a professor of finance. I prefer to live in
    academia, not in politics. And the reason I do that is because,
    in academia, I show that with the evidence. In politics, it is
    not as such.
        I was talking to a friend last night, and I was saying, you
    know, my challenge tomorrow at the hearing, I have the facts,
    they are not my facts; I have official documents, audited
    statements, the ones available, official numbers from the
    planning board, and I know what the facts say. But you don't
    know me. Anne Krueger is a respected person in economics.
    Moody's is a respected person in economics. I assure you in my
    Corporate Finance Ph.D. class, we examined the scientific
    evidence, and part of that evidence talks about how analysts in
    financial markets don't stand a chance in terms of how they
    perform the analysis.
        But, again, you are bound to trust Moody's. I understand.
    The scientific evidence questions their judgment. But the facts
    are not what they are saying there.
        Senator Durbin. Thank you.
        Senator Perdue. I just have--we are trying to finish by
    around noon, to be respectful of your time as well. We really
    appreciate your time today. I know Senator Blumenthal has a
    question or two left, but I wanted to ask just a couple myself.
        I've been interested in Puerto Rico since I recognized the
    potential there, the economic potential of that part of the
    world. I've been involved in Puerto Rico since the 1970s, and I
    was involved in major economic development work in Aguadilla,
    Mayaguez. I actually learned to surf in Rincon, but we will
    talk about that another day.
        I am very concerned that today we are talking about--and,
    Mr. Carrion, I agree with you. The potential there is
    unlimited, but we're--this is not a crisis that just came up in
    the last year or two. It has been coming for decades. I
    remember in the 1970s, we talked about economic development
    around water and power and labor and infrastructure. Here today
    we had those same four quoted today, talking about how to get
    the economy going there.
        I am really concerned that whatever we do here, we end up
    with Puerto Rico's ability to access capital, because without
    that, as we have all said, there is no future economic
    development. With that, you have to maintain confidence in the
    markets where it comes from. So, that is my driving motivation
    as just one member up here.
        Mr. Pollock, I would like to have you just talk a little
    bit more about your experience with this control board,
    authority, whatever--however we are going to characterize that.
    I know it has been done several times--the District of
    Columbia, you guys mentioned New York Municipal Assistance
    Corporation back in the `70s. Talk to us about the
    applicability of that here. What were the deficits that were
    mentioned earlier? I think, Mr. Ravitch, you mentioned some of
    the problems that we had with those earlier. Can you talk to us
    about how that would potentially be an alternative here?
        Mr. Pollock. Thanks, Mr. Chairman, and I think you are
    absolutely right that the economic problems have been long
    developing and have basically, in my judgment, come from a
    government-centric as opposed to a market-centric approach to
    the development of Puerto Rico, which was a huge long-term
    mistake which we should not repeat.
        The other cases I think are very interesting. I discussed
    three. Of course, they are all different in different ways, but
    they are all the same in that you have a public entity which
    has overborrowed--overborrowed. In the case of New York City,
    it actually did default on its debt, on its short-term notes.
    In all cases, you had a series of deficits leading to financing
    of financing of deficits by debt and just borrowing to spend
    current money, as I said in my testimony. And in all cases, you
    had to come in with a different governance structure to get
    control, first of all, of what the facts are and, second, what
    the decisions are.
        As Secretary Simon, who was earlier cited, said after the
    New York experience, by forcing the issue in New York they made
    the city of New York and the State of New York make decisions
    which they otherwise never would have made. I think that is
    also likely to be true of what would happen in Puerto Rico
    under--under such a structure.
        In Detroit, as was correctly said, the first step was an
    emergency manager. An emergency manager under the law of the
    State of Michigan has extremely wide fiscal and political
    powers that have been quite controversial. That was the first
    step which then indeed did lead to bankruptcy but was very
    important, the emergency manager, in getting control of what
    the situation was.
        And in Washington, which is relevant because it is, as I
    said, not a State and, therefore, directly subject to the
    jurisdiction of Congress, without the intervention of the
    sovereign Federal State, you had what I think of as a very
    interesting bipartisan process which structured the control
    board. They had two outstanding chairmen of this board, Andrew
    Brimmer and Alice Rivlin. I think the point is right about who
    is on the board is essential. You would want an outstanding
    chairman, as Washington did. You have to think a lot about the
    representation, and that's extremely important, and the various
    powers. But it has to be, in my view, a fairly powerful board,
    and I will just mention one particular power that Washington
    had, which I think might be repeated for Puerto Rico, and that
    is, the require--the requirement that the board approve an
    independent chief financial officer for the jurisdiction, which
    could be appointed and by the government but approved by the
    board and not removable by the government so that you get this
    really independent financial discipline, which in all these
    cases, in my judgment, is essential.
        Senator Perdue. Thank you. Mr. Ravitch.
        Mr. Ravitch. A correction. New York never defaulted. The
    Municipal Assistance Corporation was created in early June 1975
    to deal with the fact that the city of New York has, as the
    Commonwealth of Puerto Rico has, improvidently borrowed to
    cover its operating deficits. New York had $8 billion of short-
    term debt maturing, and there was no way whatsoever New York
    could pay it.
        So, the first step, which was not imposed by anyone in
    Washington but was suggested by the Governor and the
    legislature, was to create the Municipal Assistance
    Corporation. And the sales tax and stock transfer tax that was
    collected by the city of New York was taken away from the city
    of New York and pledged to the holders of the long-term MAC
    bonds. So, the general obligation debt of the city of New York
    was impaired by removing from the city a great deal of the
    city's revenues, and the financial community did not object to
    that at all.
        The control board was not created until September of that
    year, and that's because there continued to be a great deal of
    reluctance on the part of both the financial community and the
    union pension funds to invest in the MAC bonds without a
    tougher set of discipline over future budgets and future
    expenditures and future collective bargaining agreements. But
    there was never a default.
        Senator Perdue. Thank you. Senator Blumenthal I think has a
    few questions.
        Senator Blumenthal. Thanks. Just a--just a few final
    questions, and I really want to thank all of you for your
    patience and your contribution. It has been very valuable.
        Mr. Carrion, you referred to the fact that the money will
    run out. The simple stark fact is the money has run out. That's
    the reason that the Commonwealth has resorted to the
    extraordinary financial gymnastics--some would say
    ``gimmick''--of clawing back money to pay its ongoing
    obligation to avoid default. Am I correct in that judgment?
        Mr. Carrion. That is correct, and I think ``gimmick'' is
    probably a more appropriate word than ``gymnastics,'' yes.
        Senator Blumenthal. And you live on the island.
        Mr. Carrion. I do.
        Senator Blumenthal. You have skin in this game.
        Mr. Carrion. I do.
        Senator Blumenthal. And I think you would agree with me
    that Puerto Rico is an extraordinarily beautiful and bountiful,
    well-resourced island with hardworking people who, through no
    fault of their own, face a potential human calamity.
        Mr. Carrion. That is correct, Senator, and that is why I am
    here.
        Senator Blumenthal. And, in fact, Puerto Rico has immense
    future potential for development.
        Mr. Carrion. I do believe that profoundly. I think we have
    great potential. We need to address this issue and make sure it
    doesn't happen again.
        Senator Blumenthal. So, like New York City, which now is
    prospering in one of its most financially prosperous eras, at
    least in recent history, Puerto Rico has that same potential to
    regain its financial health and, in fact, prosper.
        Mr. Carrion. I believe that, yes.
        Senator Blumenthal. But to do so, it really needs to avoid
    the chaos, financial chaos and human chaos, that would ensue
    from the inability, in effect, to function. It's not just to
    pay its debts. It's to function as a society and a civilized
    entity. Am I correct in that?
        Mr. Carrion. Yes, and as has been said here, that ability
    must go hand in hand with some guarantees that this will not
    happen again, and that's the reason for some type of oversight
    or control board, together with--with some efforts to start
    increasing private investment into the island.
        Senator Blumenthal. So, it is a kind of quid pro quo.
        Mr. Carrion. Absolutely.
        Senator Blumenthal. A control board is a necessity or a
    condition for the extension of bankruptcy protection.
        Mr. Carrion. Yes. This should not be a freebie. It needs to
    have some pain associated with it, yes.
        Senator Blumenthal. And you were not initially a--a
    supporter of Chapter 9 protection. Am I right in that view?
        Mr. Carrion. That's correct. As I mentioned earlier, I am a
    banker. I am usually not in the position of lobbying for
    bankruptcy laws. But I have very reluctantly examined this
    issue over the past few months and have looked at the cash
    situation and have, again, reluctantly and with a profound
    sense of shame, come to the conclusion that this is necessary.
    And, you know, I am sorry about it, but it has to be done. We
    have to start again. Some regime to sort out all these
    competing claims needs to be put in place. Some type of board
    to oversee the spending and the revenue projections has to be
    put in place, and hopefully some economic stimulus has to be
    added to the process.
        Senator Blumenthal. Because the alternative, as Mr. Ravitch
    has said so well, is endless acrimony, litigation that only
    enriches the lawyers. It doesn't create wealth for anyone else.
        Mr. Carrion. Unfortunately, we can't go long on law firms,
    but I think that's correct, and it's very difficult to project
    what dynamic that would unleash.
        Senator Blumenthal. And I am a lawyer. I don't begrudge my
    profession financial----
        Mr. Carrion. Well, nobody is perfect.
        [Laughter.]
        Senator Blumenthal. Just so, I do not offend anyone here,
    you are all honest, all you lawyers here. But if we can save
    money for the people of Puerto Rico----
        Mr. Carrion. Absolutely.
        Senator Blumenthal [continuing]. The 3.5 million Americans
    who live there, all the better, and assure that Puerto Rico
    does not become the Argentina of America, in effect. It's not
    of the Caribbean. The threat is that it becomes the Argentina
    of America.
        Mr. Carrion. Yes.
        Senator Blumenthal. Thank you.
        Mr. Carrion. Thank you. Thank you, Senator.
        Senator Perdue. Professor, I cut you off earlier, and I
    reserved a few minutes for you. We have run over just a minute
    or two, but I would like to give you the opportunity, if you
    would like to respond to that earlier question.
        Mr. Colon de Armas. Yes. First of all----
        Senator Perdue. Could you turn your mic on? Thank you.
        Mr. Colon de Armas. First of all, thank you. On these last
    comments, Senator Blumenthal, you gave us a nice, heartwarming
    narrative. If it only were backed by the evidence, it would be
    excellent.
        But my earlier point was regarding negotiations, and people
    have made a big deal about the fact that many bond holders have
    shown willingness to negotiate. We have to be careful about
    that because, remember, in my stand--from my standpoint, I look
    at what is best for Puerto Rico, not necessarily the bond
    holders. A hedge fund will find great advantages to
    negotiations, because for a hedge fund, a negotiation is a way
    to make a profit, realize a profit on bonds purchased at a
    steep discount.
        A regular bond holder, a regular investment fund, widows
    and orphans, a negotiation is a way to cut their losses and run
    away from Puerto Rico. The key question is, will they ever buy
    a bond again from Puerto Rico?
        For a politician, a negotiation is excellent because it is
    a way to save cash in the short term to see if you can get to
    the next elections.
        Puerto Rico is a long-term project. What is important to me
    is that we protect the viability of Puerto Rico for the long
    haul. For the standpoint of Puerto Rico, we need to make
    decisions based on the correct data. We need to change
    strategy, turn around that strategy 180 degrees, and correct
    course. That is what Puerto Rico needs.
        Senator Perdue. Thank you. On behalf of the Committee, I
    want to thank you for your patience and forbearance today and
    for your testimony. It has been very helpful.
        As always, we will keep the record open for 1 week for the
    submission of written questions and other materials. If you are
    approached, please respond accordingly. And, again, thank you
    so much.
        The Committee stands adjourned.
        [Whereupon, at 12:07 p.m., the hearing was adjourned.]
        [Additional material submitted for the record follows.]
        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                A P P E N D I X

                                       to

                         PUERTO RICO'S FISCAL PROBLEMS:

                            EXAMINING THE SOURCE AND

                             EXPLORING THE SOLUTION

    The following submissions are available at:

      https://www.govinfo.gov/content/pkg/CHRG-114shrg52553/pdf/CHRG-
        114shrg
        52553-add1.pdf

    Submitted by Senator Grassley:

     Pantojas-Garcia, Emilio, statement...............................     2
     Puerto Rico-USA Foundation, statement............................    12
     Ramos, Hon. Luis Vega............................................    17
     Rossello, Ricordo, statement.....................................    21
     Velez, Gustavo...................................................    28

                                     [all]