The Puerto Rico Bill Should Become Law

One must hope that the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) which passed the House 297 to 127 is not blocked by the strenuous lobbying efforts of the hedge fund community. Not only does the Bill eschew any use of US taxpayer money in helping to resolve Puerto Rico’s economic and financial crisis, it also provides a framework for a restructuring of Puerto Rico’s debt in a manner that might be in the best long-term interest of both the island and its creditors.

At the heart of the PROMESA Bill are two provisions. The first would set up a seven-member independent and outside control board for the island along the lines of that which had earlier been set up in 1995 to resolve the District of Columbia’s financial difficulties. That control board would be charged with improving financial transparency, ensuring improved budget performance, and making the Puerto Rico government more accountable for its actions.

The Bill’s second basic provision is that it would set up a framework for the voluntary restructuring of the island’s $72 billion debt mountain. This includes a temporary stay on law suits that might be brought against the island, which would be aimed at sparing the island from a legal free-for-all that could have costly economic consequences. It also includes the introduction of collective action clauses into Puerto Rico’s 18 different bond instruments that might facilitate their more orderly and voluntary restructuring.

A principal strength of the PROMESA Bill is that it does not involve any US taxpayer money either to prop up the island’s economy or to bailout its creditors. Instead, the Bill seems to recognize that there is a moral hazard issue in Puerto Rico and that this issue cuts both ways.

Specifically, the Bill recognizes that Puerto Rico arrived at its present very difficult economic and financial pass not simply as a result of highly irresponsible public spending activities and of the egregious mismanagement of its economy by the Puerto Rican government. It also got there as a result of the highly reckless lending behavior of its creditors. Those creditors were blinded to the island’s economic and financial vulnerabilities by the lure of high tax-free interest rates. As a result, they failed spectacularly to do the most basic of due diligence analyses of the island’s longer-term economic and financial prospects.

The PROMESA Bill appears to strike a good balance in addressing the moral hazard issues. By setting up a control board that will be empowered to demand tough budget action from the island’s government, it sends a clear signal to other territories and US States that there are serious costs to economic mismanagement and that Congress will not offer an easy way out to be financed by taxpayer money. Similarly, by eschewing any notion of a tax-payer funded bailout of its creditors, and by providing a framework for an orderly debt restructuring, the Bill sends out the clearest of messages that there are costly consequences to reckless lending.

This is not to say that the bill is by any means perfect. After all, it has very little in it by the way of measures that will put an end to the island’s ten-year economic slump or to the worrying and growing outward movement of its population to the mainland. However, by imposing fiscal discipline on the island and by providing a framework for much needed debt restructuring, it makes a good start to restoring economic and financial stability to the island without the use of US taxpayer money. For those reasons alone, one must hope for the speedy passage of the PROMESA Bill.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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