Tuesday, June 14, 2016

Puerto Rico, Congress and the rule of law.

Late last week, in a remarkably bi-partisan manner, the House of Representation passed the Puerto Rico Oversight, Management, and Economic Stability Act. If the legislation makes its way through the Senate and onto the President's desk, it would establish a financial control board to govern the finances of the Commonwealth of Puerto Rico--similar to how municipal financial crises have been handled over the past half century. A moratorium would be established on the repayment of more than $70 billion of Puerto Rico debt until the new financial control board determines what needs to be done.

The legislation achieved support across the aisle in part because it involves no appropriation of federal funds, and thus does not provide a bailout for Puerto Rico from taxpayer funds. Instead, it lays the groundwork for a "bail-in," by which whatever financial relief is made available to Puerto Rico government will come from holders of Puerto Rico bonds who will "voluntarily" provide financial relief to the Commonwealth by forgoing all or a portion of what is due to them.

Few of the actors on the ground seem to be particularly happy with the proposed solution to the Puerto Rico crisis, which is touted along with the bi-partisan support for the legislation as further evidence of its fairness. To Puerto Rican activists, the Congressional imposition of an undemocratic financial control board is a usurpation of Puerto Rican sovereignty and marks a return to colonial rule by Congress. To investors that hold Puerto Rico bonds, the legislation lays the ground work for the unilateral abrogation of legal contracts and constitutional protections upon which financial markets rely.

But both of these perspectives are flawed at the most fundamental level. The proposed Congressional action does not suggest a return to colonial rule for the simple reason that Puerto Rico is a colony. And the proposed legislation does not grant any new power to Congress to intervene in Puerto Rico's contractual relationships and unilaterally dictate the terms of a restructuring of Puerto Rico debt, as Congress has always had complete authority to do so. The Puerto Rico financial crisis is unlike any other state or local government financial crisis--or Greece for that matter--because Puerto Rico is unlike any other state or local government. Indeed the Puerto Rico financial crisis is not a financial crisis at all, but evidence of two deeper problems that that the House legislation fails to address. First, the Commonwealth of Puerto Rico is a colony of the United States, and does not want to be. Second, Congress is responsible for the administration and welfare of the territories, but it does not want to be.

A bit of history and background are important to understanding how Puerto Rico and Congress got into the current situation. Puerto Rico is war booty, won by the United States--along with the Philippines and Guam--under the Treaty of Paris that marked the end of the Spanish-American War in 1898, whose status under the U.S. Constitution has remained unchanged in the intervening century. Under Article 4 of the U.S. Constitution--in what is referred to as the Territories Clause--Congress is responsible for the administration of the territories. Territory is America-speak for colony. The United States has had many territories over the years. Some, like the Philippines, have gone on to become independent, while others petitioned for and were ultimately granted statehood.

In 1952, the people of Puerto Rico proposed, and Congress and the President approved, a constitution giving home rule to the Commonwealth of Puerto Rico. In the Spanish version of that constitution, the name given is Estado Libre Asociado de Puerto Rico--or literally the Associated Free State of Puerto Rico. However, as the Supreme Court has repeatedly ruled, neither the granting of home rule, nor adding commonwealth or associated free state to its name, changed the status of Puerto Rico as a territory, nor lessened the authority of Congress over its affairs. While in the eyes of many, the approval of the Puerto Rico constitution changed everything, in the eyes of the Supreme Court, it actually changed nothing.

This week, the Supreme Court once again affirmed the Constitutional status of Puerto Rico as a ward of Congress. At issue was the Puerto Rico Recovery Act that would have allowed Puerto Rico to bypass Congress and unilaterally set the terms of a restructuring of its debts. During oral arguments earlier this year, Justice Sonia Sotomayor seemed intent on ignoring the essential fact of Puerto Rico's territorial status and its exclusion by Congress from the federal bankruptcy code when she suggested that Puerto Rico must have the latitude to restructure its debts. “It is inherent in state sovereignty that states have to have some method, [of addressing issues of insolvency]” Justice Sotomayor argued, conflating the rules governing states with what she seemed to feel should also apply to Puerto Rico.

In a similar vein, Justice Ginsburg asked, “Why would Congress put Puerto Rico in this never-never land? That is, it can’t use Chapter 9 [bankruptcy], and it can’t use a Puerto Rican substitute for Chapter 9.” But Congress did not put Puerto Rico in never-never land, the Constitution put Puerto Rico in the hands of Congress. Under current law, and as consistently affirmed by the Supreme Court, Congress is the bankruptcy court for Puerto Rico. It is the sovereign parent with full power and responsibility for the welfare of Puerto Rico. That may be never-never land in the eyes of Justices Ginsburg and Sotomayor, but it was not never-never land in the eyes of James Madison. And this week, in a 5-2 decision--with Justices Sotomayor and Ginsburg dissenting--the Supreme Court once again reaffirmed the plenary authority of Congress over Puerto Rico, as set forth in the Territories Clause.

This week's ruling by the Supreme Court cast a light on the failings of the legislation that passed the House just days earlier. As satisfying as it might be in this era of anti-Wall Street hostility to solve the Puerto Rico debt problem with money taken from bondholders, the House legislation will do little or nothing to fix the constitutional dilemma that is the underlying problem: Puerto Rico is a colony of the United States but does not want to be, while Congress is responsible for the administration and welfare of the territories but prefers to ignore its responsibility.

For decades now, Congress has failed in its essential Constitutional responsibility for the welfare of the territories, most notably in the case of Puerto Rico. Members of Congress sat on their hands as one Puerto Rico administration after another pursued policies destructive to the long-term health and fiscal sustainability of the Commonwealth, for their own political gain. In the early 1990s, pro-statehood politicians on the island advocated for the elimination of the Section 936 tax provisions that had been essential to the economic development of the island and that sustained an estimated 165,000 manufacturing jobs--and as much as 40% of the island's GDP. For years, Puerto Rican activists advocated for the closure of the Roosevelt Roads naval base and, in particular, military operations on the island of Vieques as part of their anti-colonial political advocacy. Political leaders of both major parties circumvented the balanced budget requirement of the 1952 English language constitution approved by Congress, choosing to follow a legal interpretation of the Spanish language version of the same constitution to sanction their layering on massive debts for operating purpose. And politicians of both political parties as well conspired in undermining the solvency of the worker pension fund that now stands as the most underfunded public pension fund in the country.

And all the while, Congress took one step after another--some by commission and others by omission--that undermined the viability of the Puerto Rico economy, giving little heed to the long-term implications of its actions, much less its Constitutional obligation. It conspired in the elimination of Section 936 of the IRS code, it approved the closing of Puerto Rico military facilities, it turned a blind eye to the underfunding of the Commonwealth pension system, and it looked the other way as one Puerto Rico governor after another circumvented the balanced budget requirements of their own constitution and built up debts they knew they could not afford.

Against this background, the Puerto Rico debt crisis is about constitutional principles and the rule of law as much as it is about fiscal mismanagement. Article VI, Section 8 of the Puerto Rico constitution approved in 1952, states that "In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law." This is a provision that was draft at the Puerto Rico constitutional convention, approved by Congress under its responsibilities set forth in the Territories Clause, signed by the President, and ratified by the people of Puerto Rico.

That kind of constitutional establishment of priorities only matters in bad economic times, such as Puerto Rico is experiencing today. After all, as long as things are going well and there is plenty of money to go around, such constitutional protections do not come into play. That is why we have constitutions, after all, to set forth the rules when problems arise, when people don't agree.

The problem of Puerto Rico dates back to the vision of James Madison for how the new republic was going to manage its territories. Last week, the House choose the easy path out of the current crisis by defining the problem narrowly as a debt crisis. Debt is an easy problem to solve in the short term, particularly when you have the power to change the rules with the stroke of a pen, as Congress does in the case of the territories. But the path that the House has chosen is fraught with unintended consequences. Should it choose the easy path forward of forcing a write-off of debts by bondholders, investors will be on notice that no territorial obligations will be secure going forward. If Congress chooses to undermine the sanctity of contracts and the rule of law and point the finger of blame at the bondholders, rather than in the mirror where true accountability lies, it will only undermine the long-term finances of all of the territories.

There is a solution that would uphold the rule of law and affirm constitutional governance, and it is a simple one. The laws securing each of the bond contracts should be upheld. As provided by Article 8 of the Puerto Rico constitution, those bonds that are general obligation bonds should be repaid from the first claim on all revenues as established therein. The bonds that are payable from a first claim on sales taxes should be repaid as those bond contracts require, so long as the sales tax revenues are sufficient to repay them. And so on down the line. Bonds whose claims are weaker, or that by law compete with the limited resources that will be left over, may not get repaid at all. That is what those bondholders agreed to, and the risk they undertook. This would not be a Congressional bailout, but rather an affirmation of the rule of law and the sanctity of contracts upon which so much else depends.

Congress is not obligated to repay any bondholder, Puerto Rico is. But if after paying the bondholders what they are contractually owed--under terms established in its own constitution--the Commonwealth cannot meet the health and safety needs of its people, Congress remains responsible to provide for the basic welfare of those citizens. Congress aided and abetted this problem as the building blocks of this crisis were put in place, one year after another, and it cannot now look in shock and horror at the mess that has come to pass on its watch, and change the laws and demand that others pay the bill.

The fundamental problem that underpins the Puerto Rico debt crisis rests in the fact that Puerto Rico is a colony of the United States, decades after America has lost interest in being a colonial overlord. But until that basic fact of Puerto Rico's territorial status is changed--and the constitutional options are statehood or independence--Congress must do more than just lay off the consequences of its own failure on others. Justice Sotomayor may have been wrong on the law, as Justice Thomas suggested in his terse opinion for the majority, but with respect to public policy she is right. Both Puerto Rico and its bondholders must have a set of rules upon which both parties can rely when things do not work out. And in the present crisis, people should not ignore the fact that one of the main instigators of how things turned out was Congress itself.

Artwork by Jay Duret. Find him at jayduret.com.

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