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Puerto Rico: Eminent Domain, Greenbacks, and the Exchange Stabilization Fund--Some Outside-the-Box Musings

posted by Adam Levitin
The Puerto Rico situation feels a little like a McGuyver episode.  How do we get out of a locked room with only a rubber band and a toothpick?  Here are some half-baked thoughts, first on the nature of the problems and then some ideas for solutions.  
To set the stage, there seem to me to be three core problems facing Puerto Rico.  First and most immediate is a leverage problem.  There’s simply too much leverage for what the Puerto Rican economy can support.  Second, there is a priorities problem.  There are lots of different issuers of Puerto Rican governmental-ish debt.  There is a lack of clarity regarding exactly who has a claim to what and the relative priorities of that debt.  Absent clarity on that matter, it is hard for creditors to negotiate a restructuring.  If everyone thinks that he or she is entitled to be repaid first, there’s not going to be a deal.  (This is a general problem of municipal debt, as local governments play lack of clarity regarding priority—e.g., the status of general obligation bonds—to borrow at lower rates than they should get.)  Third, there is a problem with Puerto Rico’s economic model, and this is a problem connected with the weird political arrangement Puerto Rico has with the United States.  
Bankruptcy (be it Chapter 9 or a Puerto Rican domestic regime) is a solution for the first and second problems.  Bankruptcy is great for deleveraging, and it creates a forum for resolving priority disputes.  But bankruptcy ain’t going to fix a broken economic model.  If a business plan isn’t feasible, bankruptcy won’t make it so.  And Puerto Rico doesn’t have a clear model for how it can support its current standard of living on its tax base.  What comparable advantages does Puerto Rico have over other Caribbean economies?  The connection with the United States, perhaps, but Puerto Rico hasn’t figured out how to really monetize that.  And Puerto Rico’s political situation doesn’t help things either.  Without a clear economic model going forward (which probably involves renegotiating the political arrangement in some way), I don’t see Chapter 9 fixing much.  Just because we’re bankruptcy lawyers doesn’t mean that bankruptcy has to be the solution to everything.  
I don’t have a solution to the economic model problem which is the core problem facing Puerto Rico.  I also don’t have a solution to the priorities problem.  Clarity will require some sort of adjudication, I think, and I don’t know any way other than bankruptcy to get everyone in one forum.  So what do we do if the path to bankruptcy is blocked? Below are some ideas that can address both the leverage and the priorities issue.  The basic idea is that Puerto Rican debt needs to be refinanced and consolidated (one creditor, one issuer, ideally).  A refinancing that consolidates in this manner will eliminate any priority questions, and sets the stage for a negotiation on deleveraging that could be linked to economic and political reforms.  In other words, deal with the immediate leverage and priorities problems and clear the deck to then address the business model.  
How could a Puerto Rican mother-of-all-exchange-offers work?  It could be a voluntary or involuntary refinancing.  I think it would probably have to be the latter to really have the effect needed.  So consider three moves that could be done independently or combined toward this end. Independently I don’t think they are transformative, but combined, they might be.  
(1) Use the Exchange Stabilization Fund.  The US Treasury Department sits on a little kitty of money called the Exchange Stabilization Fund.  It’s supposed to be used for currency stabilization… but that’s been interpreted liberally in the past, including bailing out Mexico and bailing out the money market mutual funds.  And there’s no private right of action to challenge its use.  There’s political accountability, but nothing more.  So why not use it to help Puerto Rico?  
The answer seems to be two-fold.  First, the ESF just isn’t big enough to do all the work.  That’s true, but there are ways to leverage the ESF.  For example, if Puerto Rico did an exchange offer for all of the outstanding types of debt (consolidating and changing terms), the exchange offer could be sweetened by having the ESF guaranty losses up to a certain level.  Second, and more importantly, there’s no political will.  Puerto Rico’s a lot like Fannie and Freddie in this regard.  Fixing it is the right thing to do, but it will cost political capital, and there’s no political upside.  As a result, nothing happens.  Put another way, the problem facing Puerto Rico really isn’t financial.  It’s political. 
(2) Issue Puerto Rican Greenbacks.  Another possibility would be for Puerto Rico to issue its own currency.  What?  How can that work?  Let’s talk mechanics first, then law, and then implications. The mechanics are pretty simple.  Puerto Rico could start to issue Puerto Rican Greenbacks in payment of its “domestic” obligations—state employees, pensioners, state vendors.  It could also issue new debt denominated in Puerto Rican Greenbacks.  (We’ll have to have a contest for the most ironic name for such a currency.)  This would let Puerto Rico hoard is US dollars for payment on its US dollar denominated debt.  The benefit of moving away from the US dollar would be that Puerto Rico could adjust its currency to fit its economic conditions. 
As a legal matter, I think this might work.  The US Constitution prohibits states from issuing “bills of credit.”  Bills of credit are just government IOUs that circulate as currency.  They are tax anticipation money (government pays in them and accepts them as payment for future taxes), as opposed to central bank money, and there’s an august history of such issuance in colonial America, including the Continental Dollar, as well as the Civil War.  Because the government pays before it taxes back, the government gets an interest free loan with bills of credit until it taxes the bills of credit back in.  But what about the Constitutional prohibition?  The prohibition on “bills of credit” is only on states.  That means Puerto Rico has an argument that either it should be treated as a state (allowing Chapter 9 bankruptcy, inter alia) or it should not be and thus it would not be subject to the bills of credit prohibition.  While I think the either/or is logical, there’s no guaranty that logic will prevent the 1st Circuit or Supreme Court from giving Puerto Rico the rope-a-dope.  
Now as a distributional matter, bills of credit sacrifice the domestic creditors for the foreign creditors.  It pays good money to bondholders and crappy money to Puerto Ricans. It’s not a full solution.  But it does buy Puerto Rico some wiggle room.  And if there were Puerto Rican Greenbacks, it would create a clearer opening for Treasury to use the ESF to support Puerto Rico (I’m sorry, to support the dollar against the Puerto Rican Greenback), as there would be an exchange market involved.  
(3) Forced Refinancing Through Eminent Domain.  The federal government or the Puerto Rican government could step in with its eminent domain power and confiscate the various outstanding Puerto Rican debt obligations.  The 5th Amendment is not a prohibition on takings.  It merely requires that the government not take without just compensation.  In other words, if the government pays market value (which sure seems like just compensation), there really isn’t a harm.  Given where Puerto Rican debt is trading, this would be a relatively cheaper solution.  Using the eminent domain power would effectively be a forced refinancing of the Puerto Rican debt—it’s a forced tender offer.  It would consolidate all the debt in the hands of one entity—the US government or Puerto Rican government—which could then proceed to a sensible restructuring of the debt.  And given that it would have been “purchased’ for cents on the dollar, the US government wouldn’t have to squeeze too hard to still come out ahead.  
But wait—where is the money to come from to pay for this forced tender offer?  Even at a steep discount to reflect market pricing, one still needs the money.  Ah, that’s where we get to have fun.  What if that just compensation were new, consolidated Puerto Rican debt (denominated in Puerto Rican Greenbacks)?  Perhaps with a limited guaranty from the Exchange Stabilitization Fund.  In other words, not a tender offer as much as an exchange offer.  If a bankruptcy plan can give creditors the value of their claim in new debt (see 11 U.S.C. § 1129(b)(2)(a)), why wouldn’t this satisfy the 5th Amendment, provided that the valuation were right.  The Kelo decision opens the door to very broad use of eminent domain.   
Now eminent domain is a red flag for some folks.  It’s hard to think of dirtier words for Libertarians and Tea Partiers (I can feel the blood pressure rising at Volokh Conspiracy!). But eminent domain it is a power given to the government.  There’s nothing illegal about it, and there’s nothing in the Constitution that would limit the use of eminent domain to taking houses to build highways, etc.  The eminent domain power allows the government to confiscate property in times of national emergency, and pay for it later.  Puerto Rico’s facing an emergency.  Why not use eminent domain?  It might just work.  The problem seems to me to be the one identified in West Side Story:  "Nobody knows Puerto Rico’s in America.”  


Adam, this is really creative and interesting. Would "taking" debt constitute an impairment of contracts?

Super-cute idea, although it requires that people actually will accept PR money. (Legal tender laws alone don't work: "not worth a Continental" refers to a currency backed up by a very strong legal tender law.)
As far as the Constitutional issues go, I think that there is on-point precedent in favor of PR money. Long Su Fan v. US, 218 U.S. 302, 310 (1910) (Philippine coinage.)

Actually the Continental was pretty successful. It financed the Revolution up through 1780. (Given the alternative currencies at the time--state bills of credit or what limited specie existed in the colonies, it seemed reasonably good). The Continental fell to 1/8 of its value over its first two years ('77-'79) and then it all went to hell, but that was because it was tax anticipation money and the Continental Congress had no power to tax--it had to rely on the states to tax in the Continental dollar. During the war, state taxation systems didn't work especially well. On top of that, the states would take both their own bills of credit and Continentals in payment. At this point Gresham's law kicked in, but with a twist--people paid with the currency they valued least (the state bill of credit), which had the perverse effect of making the state bills of credit more valuable than the Continental dollar.

But this points to a problem for Puerto Rico. It wants to pay in PR Greenbacks, but tax in in US dollars. It can't do that. If it pays in PR Greenbacks, it cannot really refuse to take them as tax payments. So it will conserve the dollars it pays out, but reduce the dollars it takes in. That will get Puerto Rico a small, one-time boost. But going forward if it can refinance the debt into Puerto Rican Greenback denominated currency, it can really do as it wants with that refinanced debt.

Thanks for the Long Su Fan pointer. I'm not sure it supports Puerto Rican Greenbacks. It supports the idea that the Philippines Commission can regulate coinage because of a delegation of the Congressional power to do so: "The power to 'coin money and regulate the value thereof, and of foreign coin,' is a prerogative of sovereignty and a power exclusively vested in the Congress of the United States. The power which the government of the Philippine Islands has in respect to a local coinage is derived from the express act of Congress." That would imply that without Congressional delegation of power to Puerto Rico, there is no power for a US territory to issue Greenbacks.

I don't know if there's anything in the laws about Puerto Rico (like a "necessary and proper" clause) that could be interpreted as such a delegation.

Thanks for these thought provoking ideas.

The greenback suggestion has a more recent precedent. During the Depression, insolvent cities issued scrip. You can see an extended discussion here: http://www.ebhsoc.org/journal/index.php/journal/article/viewFile/6/6

I don't like the eminent domain idea for reasons other than political preference. It sets a precedent which would result in less investor confidence in municipal securities and thus higher interest rates for US state and local governments.

A better alternative is a tender offer like the City of Hercules, CA did a couple of years ago. http://www.prnewswire.com/news-releases/city-of-hercules-may-default-on-its-electric-system-revenue-bonds-if-tender-fails-250814031.html.

Great to have you part of our discussion, Marc! I couldn't make the Hercules link above work but found one of your posts on the issue here that Credit Slips readers will want to see:


Not sure the market price for PR debt is the correct price for takings purposes. Part of the market price is the liquidity premium. Holders not selling their debt don't seem to want the liquidity, they want the value of their contract or what they can negotiate in good faith with the debtor.

Also, using a taking here is a horrible precedent, but hey, we live in a post Kelo world.

I agree that the "takings" idea sets a terrible precedent and would raise interest rates on U.S. debt (if the world knows the U.S. is willing to do this, it has to make their bonds more risky), but I do think a "taking" here would be legal. I think the market price is "just compensation." I'm not really tracking with the liquidity premium discussion above. How could the market price not be just compensation— by definition that is what it is. Is there anything the U.S. could do to make the market believe this taking would be a one-time event? Thus avoiding the precedent and, round-aboutly, bailing out PR?

We are intrigued by your idea of using eminent domain. Two questions come to mind: (1) must eminent domain merely consolidate the debt at a higher tier (i.e. shift the debt into PR’s hands instead of PREPA and municipalities) or could eminent domain be used to issue restructured debt as compensation for outstanding debt (within some bounds to avoid crossing the line into a takings) and (2) would this trigger some sort of "bad faith" fraudulent conveyance problem if it involves a substantive change in the ability of creditors to collect?

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