Puerto Rico’s Impending “Bankruptcy”

Puerto Rico has been struggling financially for years.  Yesterday the U.S. territory  decided to invoke a new federal statute that will allow the island to go through a process something like bankruptcy, in hopes that it will be able to shed its crushing debt load and get a “fresh start.”  Puerto Rico owes $74 billion to bondholders and has another $49 billion in unfunded pension obligations and has been unsuccessful in convincing Congress to bail it out or cajoling creditors into making concessions.  Making timely principal and interest payments on its debt requires $3.5 billion in payments a year, but Puerto Rico has only $800 million to spare.  The inexorable results of that math made the quasi-bankruptcy inevitable, triggering what will be the largest government “bankruptcy” process in U.S. history.

no-bailout-puerto-ricoThe process will be something like a bankruptcy because Puerto Rico — like every U.S. state and territory — technically cannot go through the traditional federal bankruptcy process.  Instead, Puerto Rico has invoked the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), enacted during the Obama Administration, which contains some elements of the bankruptcy laws but also includes special provisions providing that, in some ways, Puerto Rico must be treated as a sovereign.  Under the PROMESA law, the process of dealing with Puerto Rico’s debt will be supervised by a federal bankruptcy judge.  Chief Justice John Roberts will appoint the judge, who will then start deciding what to do with Puerto Rico’s appalling financial problems.

Puerto Rico invoked PROMESA because a stay that had prevented creditors from suing ended and a series of creditors immediately filed suit, hoping to be first in line to be paid.  The PROMESA law stops those lawsuits and, Puerto Rico hopes, will give it substantial leverage to negotiate with creditors and try to convince them to take pennies on the dollar for the debt — with the threat that, if creditors don’t agree, the federal judge could impose an even more draconian result.  Creditors are furious.  Republicans in Congress aren’t willing to go with a bailout option, arguing that Puerto Rico has already received big federal subsidies and should explain why it got into this predicament.

It’s an entirely reasonable request that, frankly, could also be made to many U.S. cities and states that face similar debt issues.  Puerto Rico’s economy has struggled for years, and Puerto Rico officials decided, year after year, to borrow to pay their operating expenses rather than doing the responsible thing:  cutting costs, pruning government employee pensions, trimming payrolls, and forsaking pet projects in favor of fiscal prudence.  Now creditors and employees who have pension obligations will have to take pennies on the dollar, and according to a federal board Puerto Rico is “unable to provide its citizens effective services” — all because Puerto Rico’s politicians were unable to make the tough decisions and kept borrowing to put off doing so until some point in the future.  Now that time has come.

Investors who may have bought Puerto Rico bonds at a discount, after the difficulties became obvious, might not be sympathetic characters, but many of its bonds likely are held by individuals who viewed bonds issued by a U.S. territory to be a pretty safe investment that would help fund their retirement years.  And employees who have earned pensions will receive less than they were promised, meaning they’ll have to tighten their belts even though Puerto Rico’s successive governments didn’t do so.  And a default of sorts on Puerto Rico’s governmental debt isn’t going to be helpful for other governmental entities that want to borrow through issuance of bonds, either.

Interesting, isn’t it, that the federal statute that allows Puerto Rico to go through the quasi-bankruptcy process — PROMESA — sounds a lot like “promise”?  Thanks to its governmental mismanagement, for Puerto Rico the PROMESA process it will be more like promises broken.  I only hope that the successive administrations who put their heads in the sand and borrowed, borrowed, and borrowed are in some way held accountable for their gross irresponsibility.

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Will Detroit Once More Lead The Way?

At one time in American history Detroit was a leader in commerce, capitalism, and civic development.  As the home of the American auto industry, Detroit experienced the boom.  More recently, Detroit has experienced the bust.  Now the question is whether Detroit will become a leader in a different way — by showing how local governments can use the federal bankruptcy laws to try to free themselves from the product of decades of financial mismanagement and shortsightedness.

IMG_5164Yesterday, federal bankruptcy judge Steven Rhodes ruled that Detroit’s pension obligations are not immune from scrutiny in a federal bankruptcy proceeding, notwithstanding a Michigan constitutional provision that specifically protects public employee pensions.  In effect, the judge said, contractual obligations that require cities to pay public pensions are like any other contracts and thus may be modified and restructured by a bankruptcy judge after all sides present evidence and argument.  It is the first clear ruling on this issue — one that is of enormous interest to other local and state governments that are dealing with the fiscal consequences of overly generous public employee benefit and pension arrangements that were reached when times were flush but that now threaten to crush the governments’ ability to provide basic services to citizens.

The bankruptcy judge’s ruling will be appealed, and the judge also has promised to be careful and thoughtful before changing any monthly pension payments.  Neither of those circumstances may provide much comfort to former Detroit employees who have retired in reliance on their monthly pension payment from the city and who now must wonder how they personally will be affected.  At the same time, Detroit’s financial challenges are so staggering that city administrators have few options.  The bankruptcy process will work for Detroit only if the city emerges from the bankruptcy with a balanced budget and financial obligations that it can realistically carry given its current, shrunken state — and employee and retiree benefit programs have to be considered as part of that process.

When we visited Detroit earlier this year we stopped to look at a famous downtown statue called the Spirit of Detroit, of a seated man holding the sun in one hand and a family in the other, with a quote from the Bible about liberty behind him.  Viewed in the context of Detroit’s current, crippling financial problems, the figure looks like he is trying to decide which way to turn.  A bankruptcy judge will now help him make that decision.

The Detroit Dilemma

Detroit is a mess — financially, socially, and otherwise.  It has filed for bankruptcy in what is the biggest municipal bankruptcy in history.

Detroit owes billions of dollars.  Its listing of creditors in its bankruptcy case is more 3,500 pages long.  Among other debts, it has huge, unfunded pension obligations to active and retired public workers.  In its bankruptcy Detroit will attempt to obtain significant cuts in those obligations.  Today, in an effort to forestall such cuts, Detroit’s two public employee pension funds are expected to file objections to the bankruptcy, arguing that the bankruptcy proceedings and the attempts to cut pension obligations violate the Michigan Constitution.  The city’s condition is so dire that it has hired Christie’s, the auction house, to value the city-owned items in the Detroit Institute of Art and advise the city on how it could “realize value” from those items.

Much of the focus has been on how Detroit got to its current state.  There is value in that process, because understanding the bad decisions and mismanagement — as well as the failure to recognize the impact of broad economic trends such as the departure of manufacturing jobs — may help other cities to avoid Detroit’s fate.  But it is equally important to think carefully about what happens now, and how America should handle the Detroits of the future.

At present, there doesn’t seem to be any appetite in Congress or in the Obama Administration for using federal money to bail out Detroit.  That’s a relief.  The prevailing view about Detroit may mean that we have moved beyond the notion of bailing out mismanaged entities, be they private or public.  (Speaking of prevailing views, advocates of governmental thrift will grind their teeth when they read the article linked in this paragraph, in which a spokesman for Detroit laments the city’s prior failure to take advantage of federal funds, which he describes as “free money.”  It wasn’t “free” to taxpayers, but local and state governments have long looked at the federal government as an endless source of money.)

It’s important that we set the right precedent with Detroit — because there will be other municipal bankruptcies, and with the massive unfunded public pension and health care obligations in states like California and Illinois, there could well be state bankruptcies, too.  I think the President and Congress are right to resist calls to bail out Detroit, and should similarly resist the the temptation to assume the obligations of badly managed states.  In the meantime, we can hope that the failure to bail out Detroit will cause mayors and governors of other troubled governmental bodies to get serious about getting their fiscal houses in order.

Bankrupt And Bewildered

Sometime this week, the city of Stockton, California will file for bankruptcy.   I’m sure the people of Stockton — all 300,000 of them — are a bit bewildered by their current grim reality.

Not too long ago, Stockton was on the move.   It built a new marina and hotel and promenade to attract tourists.  It built vast tracts of housing in an effort to lure bargain-hunting workers from the Bay Area.  It offered generous pay and benefits to its workers, including allowing them to retire at age 55.

Then the crash came.  The vast tracts of housing sit largely vacant, and Stockton has the second-highest foreclosure rate in the country.  The hoped-for boom in tourism and convention traffic never materialized.  Stockton boasts the second-highest rate of violent crime in California and a 17.5 percent unemployment rate.  The city has been cutting payroll for years, including a 25 percent cut in the police force and a 30 percent cut in the fire department payroll.  Public employee pay and benefits have been reduced.  Yet still the city faces a $26 million budget deficit and $417 million in liability for retirees’ health care.  When mediation talks with public employee unions and creditors failed, bankruptcy became the only option.

If I lived in Stockton I’d have one question:  how did city government fail so colossally?  Stockton looks like one of those cities where bones were thrown to everyone:  big dream city projects for the pro-development crowd, big pay and health care benefits and pensions for the public employee unions, big promises of progress and better days ahead for voters, and pats on the back and big salaries for city leaders.  Now that it has turned to ashes, city residents are left in a crime-ridden, devastated city that has to do untenable things like totally eliminating healthcare benefits for city retirees.

I guess, therefore, I’d have a second question:  where is the accountability for the city leaders who allowed the city to stroll, dream-like, into this predicament?

States In The Red, Looking For A Way Out

As even a casual follower of the news knows, many states are struggling with huge budget problems.  Ohio is one of them.  Usually the problems are the result of declining tax revenues, increased government spending and support obligations, and the fact that bills are starting to come due on grossly underfunded state employee pension and retirement plans.

States are taking different approaches to their predicament.  Illinois recently enacted huge increases to its individual and corporate income taxesCalifornia has declared a state of fiscal emergency.  Some states have focused exclusively on cutting spending.  And, it now appears, other states have quietly gone to Congress to explore the possibility of either a federal bailout or changes in the law to allow states to declare bankruptcy.  In these Tea Party days, there doesn’t seem to be much appetite for bailouts — especially for states that seem to have behaved irresponsibly with their budgeting decisions and can’t be trusted to behave responsibly in the future.  So, the “bankruptcy option” evidently is being seriously explored as a way to allow states to avoid their pension obligations.

I’m opposed to a federal bailout of the states.  I’m also opposed to any change in the law to facilitate states wiping out their debts through a bankruptcy-type process.  I think the bankruptcy option would be bad policy for two reasons.  First, I think such an approach is not fair to people who have agreements with the states that would be affected by a bankruptcy process.  State employees who have worked for years on the understanding that they will receive a pension should not be deprived of their pension payments.  For those workers, the pension was part of the deal, they have relied on the pension in their retirement planning, and it would be unfair for states to now renege on the deal.  Second, bankruptcy would affect not only state workers with pensions, but also all people who have contracts with the state, all people who purchases state bonds and debt instruments, and all others who do business with the states.  It would be a drastic step that would, I think, forever affect the state’s credit rating and investor confidence in government securities generally.  States that have been responsible in their budgeting and spending would be tarred, too, and would have to endure higher interest rates on their own borrowing as a result.  Obviously, neither of those results would be welcome.

The solution for states that are in a budget bind should lie in the state, itself, making the tough choices and difficult changes necessary to get their fiscal houses in order.  Cut spending.  Eliminate programs that aren’t essential.  Sell state property and assets.  Negotiate changes  to future pension obligations and eliminate pensions for newly hired employees.  Change laws that require automatic escalations in pension payments.  Explore users fees as additional revenue sources.  But don’t come to Uncle Sam for a bailout, and don’t take a bankruptcy option that could leave retirees high and dry and cripple state credit ratings for decades to come.

Lessons From The Blockbuster Bankruptcy

On Thursday, Blockbuster Inc. filed for bankruptcy.  The retail video rental chain, which employs about 25,000 people, is close to $1 billion in debt and is getting hammered by Netflix and other companies that offer different approaches to delivery of movies and entertainment options to consumers.

I haven’t been to a Blockbuster store in years, but I pass one on my commute to work every day, and there has been a noticeable decline in traffic at that store.  Consumers obviously prefer the mail order/on-line alternatives to driving to the nearest Blockbuster store, rummaging through the shelves in hopes of finding a worthwhile video to watch that night, and then paying late fees when they forget to return the movie in timely fashion.

The lesson of the Blockbuster bankruptcy is that the tastes and practices of American consumers are ever-changing and often influenced by new technology — which is why so many people are skeptical when the federal government tries to pick winners and losers, subsidizes particular industries or lines of business, or otherwise attempts to influence consumer choices or the direction of the American economy.  Blockbuster was once a mighty company, with busy stores in every shopping mall.  People who looked at the company in its heyday probably thought that, of course, Blockbuster would be profitable indefinitely.   When something better came along, however, Americans left the Blockbuster model behind without a second thought.

At least no one is suggesting that we should bail Blockbuster out.

The Steady Drip, Drip, Drip Of Bad News (Cont.)

Sigh.  As I’ve noted recently, the bad news just keeps coming.  Yesterday the troubling story was about personal bankruptcies reaching a five-year high.  Today it is reports of another “surprise” increase in new filings for unemployment benefits, which reached the highest weekly total in nine months.  When every day seems to bring a fresh sign of ongoing economic turmoil, it is difficult to be optimistic.

What does this onslaught of bad news mean?  It means that, more than two years into this recession, we aren’t seeing significant improvement in our economy.  What we have tried has not worked, and it clearly is time to try another approach.