The Nobel Prize and Puerto Rico

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Maria de los Angeles TrigoSeptember 2015

Prof Joseph E Stiglitz published a no-holds-barred Op-Ed in the Wall Street Journal on 13 August explicitly calling the US to task for its “imperialist past and neocolonial present” regarding Puerto Rico.

Two weeks before, on 28 July, he had given the keynote address of the third working session of the UN Ad Hoc Committee on Sovereign Debt Restructuring Processes. His address discussed factors to be considered in the preparation of an international framework for the restructuring of sovereign debt.

There is no political correctness, white-washing or sugar-coating from Prof Stiglitz: his indictment of the sovereign debt capital market follows the same principles as his indictment of the US government regarding its policies over Puerto Rico.

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I discuss Prof Stiglitz’s address to the UN in the context of Puerto Rico for two reasons:

1. his recommendations to the Ad Hoc Committee on the reforms needed in the sovereign debt capital market are applicable to Puerto Rico as an issuer of sovereign debt, and

2. it brings to the forefront the many US-created restrictions that Puerto Rico has to confront (and cannot overcome) to service its debt and to prepare a fiscal and economic development plan. Most of Puerto Rico’s economic policy variables are under someone else’s control — someone whose interests do not necessarily align with Puerto Rico’s.

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TABLE OF CONTENTSTHE UN ADDRESS

• Finance for Development

• Why Now

• Inefficiencies and Inequities

• Approaches to the Framework

• Shared Responsibility

• Additional Remarks

THE WSJ OP-ED

• “Imperialist past and neocolonial present”

MY CONCLUSION

• Expensive Limbo

EXTRAS

• Interesting Articles

• Related Posts

• Biography and Contact Information

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THE UN ADDRESSKeynote address of the Third Working Session

of the UN Ad Hoc Committee on Sovereign Debt Restructuring Processes

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FINANCE FOR DEVELOPMENT

Debt is one of the sources available to sovereigns to finance development. However, this financial source is impaired for developing countries because of the lack of an adequate way to deal with a country’s excessive indebtedness, a time when countries need a fresh start and the restructuring of debt.

Since the International Monetary Fund is an institution of creditors, it is not the institution where this discussion of a remedy for excessive indebtedness should take place. “You would not ask Citibank to design the bankruptcy law in the US” — which would then include “indentured servitude” and “debtor’s prisons.”

There is a need for fair and efficient bankruptcy laws — and laws coming out from creditors would be neither fair nor efficient.

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WHY NOW

Prof Stiglitz discussed five reasons why this issue has reached the top of the international policy agenda:

I. Present and prospective crises

II. Incoherency of the system

III. Difficulties of debt renegotiation

IV. Credit default swaps

V. The growth of “vulture funds”

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I Present and prospective crises

Many countries are facing problems of excessive indebtedness:

• Greece

• “America’s colony, Puerto Rico, is facing a debt crisis”

• and many countries that are facing potential crises

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II Incoherency of the system

Court rulings, particularly in the US and UK, have highlighted the incoherence of the current system and have made debt restructuring in some jurisdictions more difficult, if not impossible.

Capitalism could not work without a framework for debt restructuring; that is why every country has enacted a bankruptcy law. However, unfortunately, there is no international framework and no international law.

What we have today is a set of incoherent norms where a jurisdiction makes a ruling that is difficult to reconcile with another jurisdiction’s, “other than the principle of might, and that’s not the principle of law to which we all should subscribe.”

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III Difficulties of debt renegotiation

A transfer of debt from banks to capital markets has increased significantly the difficulties of debt renegotiation, since there are so many more creditors with, often, conflicting interests.

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IV Credit default swaps

The presence of credit default swaps, which is not as well recognized as it should be. CDS are financial instruments for shifting risks.

That means that the parties at a debt renegotiation may have “no economic interest at a settlement,” since they would be paid in full in case of a default. They could have an interest in impeding or blocking a settlement.

The consequences of “the separation of the ownership of claims and economic interest” have not been completely considered. [Argentinian Finance Minister Axel Kicillof had mentioned this issue in his address to the Committee.]

It is “imperative” to take this consequence into account.

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V The growth of “vulture funds”

The increased participation of hedge funds in the sovereign debt market.

These funds’ business model entails holding out on settlements and using litigation to get for themselves payments that are higher than those received by creditors who have agreed to debt restructuring. This makes restructuring under existing institutional arrangements much more difficult, if not impossible.

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INEFFICIENCIES AND INEQUITIES

The dysfunction in the international debt market creates both inefficiencies and inequities.

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Inefficiencies

A consequence of the lack of a restructuring framework is delays in restructuring, which are very costly and bring about “asset stripping” while the economy worsens. [UNCTAD’s Roadmap and Guide for Sovereign Debt Workouts discusses this effect.]

With the absence of a debt restructuring framework, economies often go into deep recessions. Or depressions, as we see today in Greece and saw in Argentina. “Totally unnecessary.”

This is not a zero-sum game. It is really a “negative-sum game,” since the losses associated with the delay in restructuring are “huge,” which we saw in Argentina and are seeing today in Greece.

But there are also costs ex ante: costs incurred prior to the issuance of the debt, since the cost and difficulty of a restructuring affects the terms and conditions under which the debt is originally issued. There are impediments in all the debt market: in its design and magnitude.

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Inequities

The dysfunction also provokes inequities, and not only between debtors and creditors, but also among different creditors.

The present system favors short-term creditors at the expense of long-term creditors.

Judge Griesa’s Argentina holding favored hedge funds over those creditors who had made real investments in the country [see also Minister Kicillof’s remarks].

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And more salient in the case of sovereign debtors, compared to private debtors, is the number of “implicit creditors” that are part of the social contract, such as pensioners. When you prioritize the “explicit creditors” before the “implicit” ones you provoke “enormous social suffering.” [UNCTAD’s Roadmap and Guide for Sovereign Debt Workouts also refers to these implicit creditors.]

Note that in the US there is Chapter 9, that both addresses the problem of distress and recognizes the rights of other claimants: not only the formal claimants, but also the informal ones which are part of the social contract.

In the absence of a formal structure, these implicit creditors are given short thrift.

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APPROACHES TO THE FRAMEWORK

The discussions in the international community have included two approaches to sovereign debt restructuring:

I Private Contractual Approach

II Principles or Statutory Approach

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I Private Contractual Approach

It has been discussed that the solution to the lack of an international framework is improving the private contractual approach. But, is that sufficient? Or is there a need for a broader approach? A statutory or principles approach? Is there a need to create an international rule of law?

When he was the Chief Economist in the World Bank during the East Asia crisis, the IMF recommendation was for countries to have a “good bankruptcy law.” Never did the IMF say that a private contractual approach would work, that “you just have to get your contracts right.” But now, when international debt is more complex, it is their position that the private contractual approach would work. That’s "wrong and hypocritical.“

Improving the private contractual approach is not sufficient. No country relies on the private contractual approach: if it were enough, there would be no need for a bankruptcy law in every country.

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Pari Passu Language

The private contractual approach discussion has considered improvements in the paripassu language, clarifying the clause and making it clear that the interpretation by the New York court in the Argentina case was wrong. “Everybody agrees on that.”

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Collective Action Clauses

Improvements in the collective action clauses have also been discussed, although this would only work if you aggregate all the bond classes — and there is no good way of doing that. When you have different currencies, different provisions, different classes of creditors, different maturities, different priorities, different jurisdictions, it is impossible to aggregate them in a “persuasive way.”

CACs can be useful, but they open issues of inequities where a majority of creditors is depriving the rights of the minority of creditors — a situation that judges are supposed to prevent.

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People in the private sector tell him that, except for Argentina, “the old system worked perfectly well.” He understands that to mean that “they could beat on almost all the countries and get their way.” Argentina was the problem “because it stood up and said we want a fair negotiation.”

CACs may help to solve the problem of holdouts, but holdouts are not the only reason we have bankruptcy laws. In the absence of bankruptcy laws there can be long delays.

Also, outcomes are determined by economic weight and might: by the party that is willing to wait and spend the most on litigation. These are not principles of social justice or even economic efficiency.

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CDS and Champerty Provisions

CDSThere must be transparency in the CDS so that all parties in a negotiation know whether anyone has an economic interest “in blowing up” the negotiation. It could be argued that those who have CDS should not be allowed to bargain.

Champerty ProvisionsThere should be a modern version of the champerty provision that would prohibit buying a bond with the intent of suing. This would be included in contracts to facilitate restructuring and provide liquidity. [The champerty doctrine is the legal name for “buying into a suit,” where a person pays another to bring a suit against a third person, to share in the judgment.]

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II Principles or Statutory Approach

We should move to a statutory approach. The principles enunciated by the committee provide the framework.

There is one principle at the core of the process and whose adoption would, by itself, go a long way to restoring the international rule of law: the principle of sovereign immunity. That no country can be sued and no government can give up its right of sovereign immunity.

The idea that some things are not subject to be contracted, that some contracts are not admissible, is an idea we all understand: for example, you cannot sell yourself into slavery. It has been determined that such a contract undermines the basic fabric of our society.

A country giving away its sovereign immunity is even more important, because of what we call the problems of political economy: one government gives away the immunity, and the costs of that decision are felt by the successor government.

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The surrender of sovereign immunity is the core of the problem, since to get the money today, a country gives up its sovereign immunity tomorrow.

No government should have the right to waive sovereign immunity. This principle should be at the cornerstone of these reforms, since the approval of this principle would restore bargaining power. It would force creditors to negotiate in good faith.

All this does is reaffirm an international principle that is more than a century old.

Accompanying this principle should be a “soft law approach:” an attempt to mediate between debtors and creditors to ascertain on a scientific basis the levels of debt sustainability: how to write down debt, in a neutral way, and using objective assessments. And figuring out better ways to restructure debt.

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SHARED RESPONSIBILITY

He issues a reminder: every loan has a lender and a borrower. A bad loan is as much the fault of the lender as the borrower.

In fact, it is more often the fault of the lender, because a lender is “supposed to be sophisticated in risk analysis,” whereas sovereign borrowers face problems of political economy. Nevertheless, the discussion of debt has fallen exclusively on the borrowers.

Debt financing are voluntary exchanges, so the rules become very important. Just as it is essential for the development of private markets to have good bankruptcy laws, it is essential for sovereigns too.

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ADDITIONAL REMARKS

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Odious Debts

The framework ought to include provisions for odious debts: those debts that are incurred in such a way to be viewed as unacceptable.

At the very least, the framework ought to provide that some debts be put “at the bottom of the list,” just as some rights ought to be put at the top.

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Sovereign Immunity

Expanding on the idea of sovereign immunity, he believes that there are times when it would be reckless to lend, especially if a country is over-indebted. But respecting the principle of sovereign immunity would encourage responsible lending, better lending practices, and increase global stability.

Making the restructuring of debt more difficult encourages reckless lending [since the lender has no incentive in conducting adequate due diligence]. A good financial market looks very carefully at whether a country can repay the debt.

He referred to what happened in the US with the bankruptcy reform of 2005, which made filing of bankruptcy much more difficult. The lending, reckless lending for those types of debtors affected by the reform, increased dramatically, and that was one of the causes of the banking crisis.

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It is only in the last 40 years that the concept of sovereign immunity has come under “concerted attack” [coinciding with the time when the sovereign debt market moved to the banking sector and the private capital markets in response to the participation in the 1970s of commercial banks because of the excess liquidity provided by petrodollars].

Importantly, the waiving of sovereign immunity has not resulted in more favorable lending terms to developing countries: it is just a way for creditors to extract more money.

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Poverty and Restructuring

There are many links between debt restructuring and poverty. Some are economic, but others are due to the underlying policies and politics.

In Greece, for example, the debt restructuring policies destroyed the economy. A destroyed economy doesn’t pay debt. And, predictably, the policies substantially increased poverty.

We need a debt restructuring framework, but one without the conditionalities that lead to the “enormous social costs” that we have seen.

Such a framework would be economically better, and would be a “positive-sum game.”

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THE WSJ OP-ED13 August 2015

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“IMPERIALIST PAST AND NEOCOLONIAL PRESENT”

In his WSJ Op-Ed co-written with Mr Mark Medish (a senior Treasury official during the Clinton administration) Prof Stiglitz lists some of the risks to Puerto Rico of depending on an “absentee landlord” and federal laws for the design of its national economic policy:

• the capriciousness by which laws and regulations may be enacted and repealed,

• the unconsidered effects of the negotiation and ratification of commercial treaties, and

• the high additional cost to Puerto Rico of the US Merchant Marine through the Jones Act of 1920

Lenders and investors have an obligation to conduct due diligence and to bear the consequences of their research — or lack thereof. But since they are unwilling to admit they “made foolish investments,” what they will do is “attempt to shift the blame.”

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Apparently the US is not ready to seriously discuss sovereignty, so the authors believe options are limited. They identify three:

1. a right to bankruptcy, either through a Puerto Rico law or Chapter 9.

2. the right to official assistance from international organizations, which would recommend that the US Congress change the laws that make Puerto Rico less competitive, including the Jones Act.

3. the US’s assumption of its responsibility for having made it quite difficult for Puerto Rico to enact a comprehensive development strategy “that is more than a set of tax breaks for profitable U.S. corporations.”

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MY CONCLUSION

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EXPENSIVE LIMBO

Puerto Rico’s situation is made worse than that of any sovereign issuer because of the unpredictable interventions of the US Congress, the US Judiciary, and the US Executive Branch.

Since the US’s government policies regarding Puerto Rico depend on the strategies being implemented by the US at any given moment, be they economic, commercial, military, or geopolitical, there is no consistency or long-term strategy in the determination of the sovereign powers recognized to the Puerto Rico government.

“Subject to the control of Congress” has cost investors a lot of money in lobbying and public relations campaigns. The indefinability that makes it easy for the US to control Puerto Rico (and define and re-define, grant and curtail powers) makes it difficult for investors to establish a strategy to recoup their investment.

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The delay in debt restructuring is impairing the value of the creditors’ investments, worsening the economy, and decreasing the possibilities of servicing debt. It is also increasing the chances of “asset stripping” through calls for privatization, which would keep decreasing the possibilities of servicing debt.

Grey areas are quite expensive. Interesting, yes, but nevertheless, expensive. The sooner Puerto Rico’s restructuring powers are defined, the more profitable for investors.

Make no mistake: Puerto Rico will have restructuring powers. So it would be better for everyone if it is sooner rather than later.

Borrowing Prof Stiglitz’s eloquent words, collective indentured servitude and debtor’s prisons are out of the discussion. Especially for US citizens.

Even those in the Caribbean.

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INTERESTING ARTICLES

Measuring the Nonsense Intensity Surrounding Puerto Rico

(Financial Times)

Deciphering Puerto Rico’s Debt Crisis

(Council on Foreign Relations)

Is an Obama Donor Tying the President’s Hands on Puerto Rico’s Debt Crisis?

(The Nation)

Archbishop: Congress Should Allow Puerto Rico To Declare Bankruptcy

(Time)

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RELATED POSTS

Crisis and Status: Puerto Rico on the Brink

Hedge Funds and the Muni Market: Puerto Rico, the Outlier

Restructuring and Due Diligence: The Front-End of Puerto Rico Debt

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Originally published in LinkedIn:

The Nobel Prize and Puerto Rico24 August 2015

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An attorney and CPA, I help clients understand Puerto Rico’s public finance market. I advise financial institutions, investors, law firms, economists, and government institutions on Puerto Rico debt’s legal and regulatory framework. I worked for 16 years with the Government Development Bank for Puerto Rico and was the highest-ranking career legal officer as Director of the Compliance Department and Acting Deputy Director of the Legal Division.

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