House Committee on Natural Resources

Subcommittee on Indian, Insular and Alaska Native Affairs

Hearing on The Need for the Establishment of a Puerto Rico Financial Stability and
Economic Growth Authority
February 2, 2016
Prepared for the Record
A Sustainable Solution to Puerto Ricos Fiscal Crisis
by
Ricardo Rossell, PhD
Candidate for Governor of Puerto Rico
&
Professor at the Metropolitan University of Puerto Rico

A Sustainable Solution to Puerto Ricos Fiscal Crisis

Puerto Ricos fiscal problems have been decades in the making and will persist until a
sustainable solution is legislated by Congress and implemented in conjunction with the
People of Puerto Rico.
In my written statement submitted to the Senate Judiciary Committee on December 1st,
2015, I emphasized that Puerto Ricos current fiscal crisis is rooted in a crisis of credibility
and how a solution that is only focused on debt-restructuring would have a limited effect on
the long-term solvency and viability of the territorys government and would destroy
investor confidence for years to come. I also stated that the imposition of a Federal Fiscal
Control Board that would effectively put Puerto Rico into receivership and make the
Federal Congress responsible for the resolution of the territorys problems is also
unsustainable and would produce unintended but foreseeable political consequences.
Ultimately, these proposals would likely just add to the long list of one-off and piecemeal
solutions to Puerto Ricos fiscal crisis.
To address the limitations of these proposals, I recommended and outlined the creation of a
Special Joint Commission with participation of the Federal and Commonwealth
governments that would provide a robust and lasting collaboration framework to oversee
the gathering and distribution of reliable financial information and the implementation of
the necessary measures for the Government of Puerto Rico to achieve fiscal sustainability.
The Joint Commission could oversee a number of government functions and initiatives,
including the establishment of a financial and operating Puerto Rico Debt Management
Authority (PRDMA) that, in conjunction with the Federal Internal Revenue Service
(IRS), would support the collection of certain government revenues and ensure that they
are segregated and allocated based on the established payment priorities, including the
balance of debt service priorities and the provision of essential services.
The PRDMA would replace the Government Development Bank (GDB) as the
Commonwealths fiscal agent and would manage all current and future debt issuances
under strict guidelines, total transparency, and independence from political considerations
and interests. By restoring credibility, reaffirming debt service priorities, and establishing
the control mechanisms to guarantee repayments and the provision of essential government
services, the PRDMA may be able to issue new debt that can serve as an instrument to
repurchase and redeem lower-priority obligations at discounts, having a similar principal
reduction effect of what could be achieved through bankruptcy and restructuring. If for
whatever reason the Commonwealth cannot meet the necessary measures and milestones
cannot be achieved within the specified timetable, the Joint Commission could expand the
charter and powers of the PRDMA to those of a Fiscal Control Board.

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A History of Short Term Patches and the Risks of Chapter 9

Since its inception, the Commonwealth of Puerto Rico has relied on a plethora of special
tax structures and schemes at the Federal and local levels to incentivize foreign and local
investment in the island and accelerate its economic development. The reliance on these
special schemes in lieu of full integration into the American political economy has left
Puerto Rico without the tools necessary to effectively compete and develop an economy
that leverages its intrinsic assets and advantages and a private sector tax-base that can
sustain the islands bloated government structures.
Specifically, the application of Chapter 9 to Puerto Rico presents a number of challenges
and risks to the islands sustainable recovery. Chapter 9 has been sold as another magic
bullet that will resolve Puerto Ricos financial crisis with no cost to either the Federal or
State governments, but nothing could be further from the truth:

Chapter 9 is just a tool not a solution which should be used sparingly and as a
last resort. We are uncertain if all other options to negotiate in good faith with
creditors and reduce government expenses have been explored and executed.

Because of the problems with Chapter 9, 23 US States explicitly do not allow their
instrumentalities access to Chapter 9 and an additional 16 of them set conditions or
require additional approval for filing.

Puerto Ricos recent track record of strategically defaulting on certain bond issues
points towards a lack of willingness to pay, and not ability to do so if certain
corrective measures are taken.

A reduction or deferral of unsecured debt obligations which could be achieved by

Chapter 9 will not address the underlying structural mismatch between revenues and
expenses of Puerto Ricos governments instrumentalities.

Different than state instrumentalities like cities, many of the distressed public
corporations in Puerto Rico which are likely candidates for Chapter 9 filings have
issued bonds against pledged revenues which would likely not be subject to a stay
under Chapter 9.

A bankruptcy restructuring plan and the enforcement of revenue pledges will likely
be accompanied with new and higher taxes and fees which will be devastating to
Puerto Ricos debilitated economy.

Most of the affected creditors will be local residents and mainland investors and
retirees that lent Puerto Rico money and bought bonds at par value, relying on the
security provided by the lack of access to Chapter 9.
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Chapter 9 will be very expensive payments to advisors are reported to have

already totaled over $100 million before any formal process has even begun. It will
be a contentious and drawn out process that is being proposed by bankruptcy
attorneys and restructuring advisors who have taken over the strategy and public
policy functions and who see Chapter 9 and restructuring in general as the solution
to every problem to a hammer, the world looks like a nail.

Chapter 9 does not provide a practical solution to Puerto Ricos immediate need for
liquidity, in contrast to the PRDMA which would have broad market acceptance.
Debtor in Possession (DIP) financing involves a small universe of specialized
lenders, is time consuming, will be very expensive, and should not be considered a
practical source of short-term financing.

New access to the credit markets will be limited and will be accompanied with
lower credit ratings and higher borrowing costs (Detroit has yet to borrow on its
own credit and has had to rely on a state level guarantee).

The damage to Puerto Ricos long-term credibility and market access will be great,
and without the stability and security provided by Statehood, it will be very difficult
for Puerto Rico to emerge quickly or sustainably from its economic and fiscal
problems.

Because of the territorys inadequate and insufficient political access and power in Federal
spheres, Puerto Rico has limited opportunities to get this right. Instead of using the current
opportunity to request access to Chapter 9, Puerto Rico should rather request greater
collaboration, technical assistance, independent oversight, and financial support in order to
regain the credibility, market access, and the political capital necessary to address the
underlying root causes of Puerto Ricos financial and economic crisis.
The Components of a Sustainable Solution
In December, I also proposed that the components of a sustainable solution to Puerto Ricos
crisis must include:
1.
2.
3.
4.

Restoring investor confidence to regain market access;

Addressing budget imbalance between revenues and expenses;
Limiting future debt growth and reduce debt, if possible; and
Implementing a coherent economic development strategy.

Additionally and as a first priority, the Federal government must both require and support
the generation and publication of accurate financial data that can be utilized by all
stakeholders to make informed and equitable decisions. However, the Administrations
policies that have led to its current lack of credibility and access to liquidity have included:
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Passing local bankruptcy legislation (the Recovery Act) and then litigating
unsuccessfully over the constitutionality of this Act;

Lobbying Congress to retroactively apply Chapter 9 to Commonwealth subdivisions

and more recently to the Commonwealth itself;

Strategically defaulting on the Public Finance Corporation and Infrastructure

Finance Authority bonds;

Negotiating in secrecy with certain bondholders rather than conducting an open and
transparent process in order to provide every constituency with the same
understanding of reality;

Threatening to default indiscriminately on all Commonwealth obligations without

regard to the priorities established by the Commonwealths Constitution, statutes
and contracts;

Delaying the publication of audited financial statements and attempting to replace

them with made-to-order cash-flow projections and analysis.

In July of 2015 the Administration approved Act 97-2015 to create an independent board to
audit Puerto Ricos debt and in December of 2015 the Administration approved Act 2082015 to create a local Fiscal Oversight Board, both of which have been virtually ignored by
the investor community, the Federal Government, and the Administration itself,
demonstrating a clear unwillingness or incapacity to act responsibly towards a sustainable
solution.
It would be frankly irresponsible for Congress to prescribe a solution to the crisis that
would impact so many stakeholders based on the limited and questionable information
being provided by the Administration without first commissioning and conducting an
independent and in-depth review of the situation on the ground. Most importantly, in order
for a solution to Puerto Ricos fiscal problems to be sustainable, it must integrate the
democratic will of the territorys residents and principal stakeholders. It is clear to
everyone on the island that the current Administration is no longer representative of the will
of the People of Puerto Rico or of their capacity to confront the crisis and take
responsibility for its resolution.
The imposition of an overarching Federal Fiscal Control Board at this point in time would
federalize the crisis and rob the People of Puerto Rico of a legitimate opportunity to assume
responsibility and resolve the crisis on their own terms. Historically, Fiscal Control Boards
and Emergency Managers have been implemented by States to manage their underlying
instrumentalities, but there is no precedent for an entity overseeing a State itself.
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Applying this construct to Puerto Rico would set back Puerto Ricos home-rule progression
towards sovereignty as a State of the Union. The implementation of a Super Chapter 9
that would supersede the territorys constitution would have a similar impact.
Collaboration with the Federal Government
Our proposed solution seeks to address the aforementioned challenges by establishing a
lasting and robust collaboration framework between the Federal and Commonwealth
governments as well as the financial and operating capacity to manage through the crisis
and beyond until Puerto Rico reaches fiscal, economic, and political sustainability. The
initial component of the proposal is the establishment of a Special Joint Commission to
manage the debt with representatives from both the Federal and Commonwealth
governments which would oversee a number of government functions and initiatives,
including the establishment of a financial and operating PRDMA and provide constant
reporting to the Commonwealth Legislature and the United States Congress. The Joint
Commission will also serve as a forum for the Federal and Commonwealth governments to
collaborate on joint economic development initiatives, including those that involve
additional Federal funding and any financial and economic aspects of a transition of the
status of the territory of Puerto Rico towards statehood
The Puerto Rico Debt Management Authority (See Appendix A)
1. Establishment of PRDMA

The PRDMA is ideally created by Federal and Commonwealth law to manage the
obligations of the Central Government of the Commonwealth of Puerto Rico and its
instrumentalities.

The PRDMA will be governed by a board of three (3) or more independent directors
named by the majority of the members of the Joint Commission, which will
continue to provide oversight and reporting to the Commonwealth Legislature and
the United States Congress.

The board members may have three (3) year terms, but the initial terms are
staggered to result in at least one (1) member per year being replaced.

2. PRDMA Revenues

PRDMA will enter into a contract with the IRS to oversee the collection of certain
Commonwealth revenues, including but not limited to income taxes and excise
taxes such as the Rum Tax and the Act 154 excise tax (collectively, PRDMA
Revenues).

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The IRS will deposit PRDMA Revenue it collects immediately to a Trust (the
Puerto Rico Trust or PRT), held by an independent trustee for the exclusive
benefit of holders of bonds issued by PRDMA (PRDMA Bonds), which will also
have a general obligation guarantee of the Commonwealth, and other general
obligation bonds of the Commonwealth of Puerto Rico (Legacy GOs). PRDMA
Bonds and Legacy GOs are collectively constitutionally guaranteed general
obligations (GOs).

The PRDMA will determine and certify to the Governor and Legislature of Puerto
Rico the amount of PRDMA Revenues and will project the amount of residual
revenues expected to be delivered to the Commonwealth each month.

PRDMA Revenues will be applied as follows:

o
o
o
o

first, payment of debt service on PRDMA Bonds and Legacy GOs;

second, any deficiencies in any reserves;
third, payment of PRDMA administrative expenses;
fourth, as a residual distributed to the Commonwealth.

The PRDMA and PRT will be maintained until Puerto Rico becomes a State of the
Union and bonds issued by PRDMA are repaid in full or provision for their
payment in full have been made.

3. PRDMA Bonds

PRDMA is authorized to issue taxable and tax exempt fixed rate bonds, which are
also GOs for a maximum term of forty (40) years with principal amortizations to
result in substantially level annual debt service.

At the time any PRDMA Bonds are issued, the maximum annual aggregate debt
service on PRDMA Bonds and previously outstanding GOs cannot exceed PRDMA
Revenues.

PRDMA Bonds will be issued with a first lien on PRDMA Revenues and will also
carry a general obligation guarantee of the Commonwealth.

Proceeds of PRDMA Bonds will be applied at the discretion of the PRDMA to

retire other Commonwealth obligations.

PRDMA will remit to the Commonwealth all PRDMA Revenues not required to
pay debt service on GOs and pay PRDMA administrative expenses.

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Retirement of Commonwealth obligations may be through open market purchases,

tenders, exercise of rights of redemption, exchanges of PRDMA Bonds, or such
other means as PRDMA shall determine through negotiation with bondholders. The
means and order of retirement shall be established to produce the lowest aggregate
expected debt service cost to PRDMA and the Commonwealth.

4. The Commonwealth Government

The Commonwealth government will continue to provide public services to

residents based on the residual revenues distributed to it by the PRDMA as well as
through the revenues it continues to collect directly and which do not flow through
the PRDMA.

The government will design and implement a comprehensive reorganization process

in order to be more efficient and effective.

The PRDMA would spring to a full Federal Fiscal Control Board if certain
triggering events, as determined by the Joint Commission were to occur, including:
o Violation of any bond covenant or payment default on any obligation unless
waived by the creditors;
o Failure to approve and implement a government-wide balanced budget
based on recurring revenues and expenses and any PRDMA bond proceeds
allocated as bridge financing during the first two (2) years of operation;
o Failure to adjust to an unanticipated shortfall in revenues or increase in
expenses within ninety (90) days of the occurrence of such an event;
o Failure to deliver any financial information or meeting reporting
requirements imposed on the government.

Public-Private Partnerships
Finally, in order to address the fiscal crisis being faced by Puerto Ricos public
corporations which represent an important component of the Commonwealths total debt
burden, they should embark on a formal path towards the establishment of public-private
partnerships (P3s) and public-private-people partnerships (P4s), for the applicable
aspects of their operations, including the necessary provisions for the management of their
debts.
P3s are successful when they are conducted with absolute transparency and when potential
investors are assured that political considerations will remain entirely outside of the
decision-making criteria. Puerto Rico has a solid track record of successful public-private
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partnerships based on the process established by Act 29-2009 which resulted in the
successful concessions of a major toll-road in 2011 and the islands principal airport in
2012. However, any attempt to privatize or establish long-term operating concessions for
any public corporation outside of the process established by Act 29-2009, such as the one
currently being proposed for the Puerto Rico Electric Power Authority (PREPA), should
be closely scrutinized.
In order to accommodate the interests of key public-sector stakeholders such as labor
unions and employee retirement systems that have traditionally been at odds with
privatization effort, the P4s can be structured to include these stakeholders as investors and
thus align the interests of these stakeholders with those of the private investors.
More than the short-term deferral or restructuring of upcoming debt-service payments, P3s
provide the long-term repayment guarantees to bondholders and most importantly, the
much needed reduction in the cost and improvement in the quality and accessibility of basic
infrastructure services to the islands residents and businesses.

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Appendix A
Conceptual diagram of the PRDMA and the flow of funds between the various entities

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