A senior Treasury official told U.S. lawmakers Thursday that they need to act now to help Puerto Rico get out from under its debt burden.
"The urgency could not be more apparent," Antonio Weiss, the third-ranking official at the Treasury Department, said during a hearing in front of the House of Natural Resources Committee. "What started as a recession has turned into a fiscal and liquidity crisis that shows signs of becoming a humanitarian one as well."
Weiss outlined the key components of the administration's multi-step plan for the U.S. territory, which is struggling to manage a $70 billion debt load.
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"We believe that there needs to be two phases to this," Weiss said. "In the first phase, the debt will need to be restructured and there has to be oversight." Treasury believes the two proposals must be enacted together in order to be successful in stemming the crisis.
Absent of these actions, Treasury believes that in the coming months the government will be forced to make difficult decisions as large debt obligations, many with constitutional guarantees for payment, come due.
"The governor has already been forced to curtail services," Weiss detailed. "As the debt payments become larger, as the most senior debt becomes due…the decisions become more difficult."
At a concurrent House hearing, William Isaac, global head of financial institutions at FTI Consulting and former FDIC chair in the U.S., warned of the potentially perilous impact allowing Puerto Rico to restructure all of its outstanding debt could have on the broader municipal market.
"I believe that the credibility of the commonwealth government and its future access to private sector financial markets will suffer drastically should they attempt to default on or restructure the general obligation debt that is given priority under Puerto Rico's Constitution," Isaac said. "The market reaction to a potential failure by the commonwealth government to repay these obligations would in the long run increase its financing costs to much greater levels, assuming it were able to access the market at all."
Isaac said he believes that a better solution is to treat Puerto Rico like any other U.S. state and allow the commonwealth's municipalities access to Chapter 9 bankruptcy laws. He estimates the plan would allow Puerto Rico to restructure 75 percent of the island's total debt.
In addition, Weiss also warned that the Government Development Bank, which has historically served as the principal source of short-term liquidity, is "dangerously undercapitalized" and that in the absence of additional emergency fiscal measures or financing alternatives, a cascading series of defaults is on the horizon.
"Debt payments in May and June, including nearly $800 million of constitutionally prioritized debt, are unlikely to be made," said Weiss.
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A default of this magnitude will likely result in mounting litigation — between competing creditor classes and also against the Puerto Rico — that Treasury believes would last for a better part of a decade, and could ultimately lead to the central government being forced to shut down entirely.
When questioned by lawmakers on how the 18 different Puerto Rico-issued bonds, all with varying degrees of legal protections, would be restructured, Weiss stressed that Treasury is not suggesting a one-size fits all solution.
"Our basic philosophy on this is that the restructuring should include all of the debt….we're not saying that the (general obligation) debt, which has a Puerto Rican constitutional priority, or some of the revenue bonds which have a claim on some of the [revenue] streams, that all those need to be treated equally," Weiss told lawmakers. "What we can do, working together, is to design a restructuring authority whereby everyone is part of the discussion, but that there is a differentiated treatment per existing priorities and claims."
The framework would also include a stay on litigation to protect the provision of vital public services and allow time for voluntary negotiations to take place, a voting mechanism to prevent holdout bondholders from blocking a reasonable compromise, and if negotiations fail, a court-supervised structure to ensure an orderly resolution.
The other time-sensitive component to Treasury's plan would be the enactment of a "strong, independent federal oversight" board that would "address the commonwealth's longstanding history of fiscal management and inadequate financial disclosure."
The second phase will focus on creating greater economic opportunity and rewarding work by granting Puerto Rico access to tools such as the earned income tax credit.