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Why Didn't Puerto Rico Use its "Local Law" Advantage to Reduce its Debt?

posted by Mitu Gulati

Good academic workshops are hard to run. I know, because this is a task that I have failed at, and continue to fail at, repeatedly.

For that reason though, it is a treat to see someone else run their workshop successfully. I was at one recently that was spectacularly run: Jill Hasday's Public Law workshop at the University of Minnesota. The setting is intimate: a small group of students and faculty gathers in the late afternoon (without wine -- which I usually think of as being key) and they take apart whatever paper is the focus of the discussion. Indeed, after about an hour, the paper that is being discussed almost becomes secondary to the idea that the participants have by then honed in on as being central.  My colleague, Joseph Blocher, and I were lucky enough to have our paper "Puerto Rico and the Right of Accession" be deconstructed last week and it was a special treat for the both of us.  We have a concrete measure for whether a workshop was good (taken from our dear friend, Steve Choi): Did it help generate ideas for a new paper?  This workshop gave us at least three.  That's more than any other workshop I've been to. I don't know how Jill inspires her students or what magic potion her colleagues who attend take, but I want the secret sauce to use next semester at my workshop series with Guy-Uriel Charles.

The one question that Jill, Daniel Schwarcz and at least two students asked that keeps bugging me is: Why didn't Puerto Rico use the fact that the overwhelming majority of its bonds were governed by its own local law to directly restructure it?  Couldn't Puerto Rico have passed a set of laws to enable it to engineer a sharp reduction of its debt?  Greece did precisely that in March 2012; and it faced constitutional protections of property and prohibitions on expropriation very similar to what Puerto Rico would have (as an aside, the challenges to the Greek restructuring of 2012 -- and there have been dozens of suits filed -- have failed so far).  Indeed, the US did something like this with the gold clauses in the 1930s, to jumpstart the economy and get it out of the depression (actions that withstood legal challenge in a set of famous cases such as U.S. v. Perry).

The reason I bring this up is that Jill, Daniel and the Minnesota students refused to let me go with an "I simply don't know". They thought that the answer to that question could itself shed light on why the crisis occurred in the first place. It might, for example, give us some clues as to the dysfunctionality of the Puerto Rico government; a level of dysfunctionality that resulted in an un-elected control board being imposed on the Commonwealth by the federal government.  The more I think about it, the more I'm curious as to why this happened.

It makes no logical sense to me that the government, mired in a financial crisis that was only getting worse, should refuse to try to reduce the debt even though it had powerful tools to do so (instead of reducing the debt, the Puerto Rican government kept borrowing more at higher and higher rates, until even that option was closed and the whole thing came crashing down). And it isn't that Puerto Rico's lawyers didn't know how to engineer this technique: the same law firm that did the Greek restructuring was working for them (no longer though) and even some of the same financial advisers (I think).  Of course, history tells us that this movie has played out elsewhere before (Greece in 2010-2013, and Venezuela now). But we don't know why.

It should be possible though to do interviews with enough of the key players in the Puerto Rican crisis to try and figure out what happened. Indeed, some of the slipsters probably have answers. Now, to try and persuade my associate dean that I should be allowed a research leave to spend a year in the West Indies investigating this question.

Comments

There is the problem of the Contracts Clause – which the First Cir. has (strangely) held is applicable to PR.

I'm confused by the premise of the question. They did put laws in place to restructure some of the debt. The Recovery Act. The US Supreme Court held it was preempted by federal bankruptcy law (whether or not it would have passed muster under the contracts clause, per Stephen's point, was still pending in district court). Haven't seen indication that the outcome would have been different depending on which US jurisdiction governed the bonds.

The comments are correct. The US Supreme Court definitively held that Puerto Rico is powerless to use local law to restructure its debt- the Constitution reserves that power to Congress. No real mystery at all.

Quite apart from the law... Neither Greece nor PR should be viewed as a fully sovereign debtor when it comes to restructuring. The local law move in Greece was coordinated with and blessed by the euro area powers that be; they also took default on the holdouts off the table. Similarly, the question of why PR did or did not use all its legal leverage, whatever it might have been, boils down to DC politics. The Recovery Act episode 1/suggests that there was not much leverage, and 2/confirms that in practice, this is a federal show.

Great comments -- MJS is exactly right that PR did try to use local law to put in place a bankruptcy scheme. And that points helps clarify my question -- which, more precisely put, is why did they try to use the bankruptcy path rather than (what I think) could have been the simpler soveriegn debt restructuring path.
SJ's point that there would likely be Contracts Clause issues is exactly right too (strangely -- given the complications as to which parts of the federal constitution apply to PR). And, if not the Contracts Clause, as SJ implies, perhaps Due Process issues would be implicated. That said, I don't quite read the Court's jurisprudence on that matter to be an absolute bar to contract reform. That said, LL might well be right -- and I'll readily concede that a deeper and more knowledgeable reading might show me the error of my ways (a frequent outcome).
As for AG's comment -- she is always right! Her point gets exactly at what I want to study -- which is the story of why the combination of DC politics, lawyer preferences (agency issues) and PR internal machinations combined to produce something of an ongoing disaster.

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