[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
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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
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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]