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Puerto Rico: Legislative Update

posted by Stephen Lubben

It appears that the House legislation has bogged down.  Two or three issues keep coming up, none of which make a whole lot of sense:

First, "bailouts."  I'm not sure if people making this argument actually believe it or are just using a convenient, politically toxic buzzword. But the claim that extending chapter 9 to include some or all of Puerto Rico constitutes a "bailout" can't really be taken seriously. A bailout involves (a) the use of taxpayer money to (b) help investors avoid realizing risks they voluntarily agreed to take.

Neither is applicable here. Instead, this is the basic insolvency process doing its thing. Namely, losses will be allocated pro rata if bankruptcy applies.  But no taxpayer money is involved, and in no case are investors being saved from their own poor investment choices.

Second, expanding chapter 9 does not raise takings or other scary "retroactivity" problems. If it did, then Congress could never have enacted chapter 9 in the first place. After all, there was no chapter 9 until there was a chapter 9.

More generally, it is quite clear that unsecured bondholders do not have a valid takings claim (under the Fifth Amendment) as a result of the enactment of a new bankruptcy law, in any context. For example, if a secured creditor is owed $1,000 and has a lien on a house worth $400, a new bankruptcy law that discharges the $600 unsecured portion of the claim raises no constitutional issues. That's Congress' power under the Bankruptcy Clause in action. A law that resulted in the creditor obtaining substantially less than $400 on the secured portion might raise a constitutional question, because the secured portion of a claim is "property" for these purposes. But that still does not prevent the rescheduling of secured debt, just the complete elimination of it.

And finally, no, no, no this does not open the door to Illinois filing for chapter 9. Illinois is a state, with full 11th Amendment and 10th Amendment powers. Puerto Rico is a territory of uncertain legal status. Apples ≠ Oranges.



I'm inclined to agree -- although I had never thought of the retroactivity issue in quite that way before. The closest analogue I can come up with is dischargeability -- because, basically, PR's creditors hold totally nondischargeable debt now, and if Ch. 9 is expanded some of that debt can be discharged. I am trying to think of any previous instance where we have expanded the discharge, thereby making existing debts subject to discharge that previously weren't. Mostly we have gone in the other direction.

What's the scoop on that now-ubiquitous television ad, about Theresa (I think her name is) and how her nest egg is in danger? My own strong hunch is that Theresa's stake in PR bonds is through an institution, pension fund or the like, and of course such bonds would be only a part of its portfolio. Hope Credit Slips can set us straight on this.

The reality is that television add is analytically irrelevant. It was almost certainly paid for by hedge funds.

The reason those hedge funds paid for it is that a favorite talking point of those in favor of allowing PR to restructure is that the people on the other side are "vulture funds" and somehow unpleasant. That point is also logically irrelevant, yet it is somehow felt to extremely important politically.

I'd never thought too much about the "vulture funds" point, but it's clearly right. My hunch is the label gets thrown around a lot to deflate the suggestion that those investors are innocent legal naifs, who would be shocked, shocked to learn that Congress can change the bankruptcy laws -- including ways that disappoint those investors -- and, so long as not affecting property entitlements, don't come anywhere close to raising any constitutional problems.

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