Rhodes: Bankruptcy Critical for All of Puerto Rico

Puerto Rico needs to be put on life support and the way to do it is through bankruptcy, said former Detroit bankruptcy Judge Steven Rhodes.

Rhodes talked about the territory's fiscal and debt crisis in a telephone interview with The Bond Buyer. He also called for a central control person or board, preferably designated by the federal government, to spearhead the proceedings in place of the island's governor and legislature.

"It is very tough on the people on the island, it is very tough on existing politicians, but the closest analogy is that when an entity like Detroit or like Puerto Rico goes into bankruptcy, they are on life support," Rhodes said. "And extraordinary measures have to be taken to assure the survival of the patient."

He said Puerto Rico's struggles with unpayable bond debt and unfunded pension liabilities closely resemble those of Detroit, where Michigan Gov. Rick Snyder appointed Kevyn Orr to serve as an emergency manager for the city throughout the bankruptcy process.

"In Detroit, we contracted democracy to a significant extent. When it was over, we handed it back to [city officials] and told them it was their responsibility to make it work," Rhodes said. "That is what I advocate for Puerto Rico."

The commonwealth retained Rhodes in June as an advisor while it deals with its roughly $72 billion of debt. Rhodes, who retired as a bankruptcy judge in February, wants a bankruptcy regime that would apply to the entire commonwealth and not just its struggling public authorities as others have suggested.

But Puerto Rico's debt diverges considerably from that of Detroit, in that the territory has a large number of different debt-issuing entities and many different bond structures that combine to make the overall debt burden. A public authorities-only bankruptcy would exclude the commonwealth's large general obligation debt.

"In a very real, practical, and economic sense, all of the entities and their fates are intertwined," Rhodes said. "And so what Puerto Rico as an entity needs is a holistic solution to all of its debt and financial problems."

He added that creditors, who have largely opposed a bankruptcy solution out of concern they would lose a significant amount on their investments, should actually welcome bankruptcy as a way to get independent judgments that: are in their best interests; are fair and equitable between them; do not unfairly discriminate between creditor classes, and; are actually feasible as Puerto Rico tries to fix its situation.

The structured process from bankruptcy is a better solution than the "one-off, year at a time" solutions creditors would pursue through lawsuits and negotiations in the atmosphere that exists now, he added.

The bankruptcy question for Puerto Rico is complex though because the Chapter 9 protections that federal law affords state municipalities and public entities do not apply on the island. Two bills pending in Congress would close that gap, but both would only apply the law to public authorities instead of the whole commonwealth.

The House and Senate bills have been stalled in the judiciary committees of their chambers by Republicans who say bankruptcy will not solve Puerto Rico's problems and that the island's government has not provided sufficient documentation of its finances. The proposal Rhodes supports has been labeled by anti-bankruptcy groups as "Super Chapter 9" that is equivalent to the federal government giving the commonwealth a bailout.

The Treasury Department also recently released a four-part plan on Puerto Rico, which calls for a federal control board and commonwealth-wide Chapter 9 protections. Rhodes said he generally supports that plan.

He said he recognizes Chapter 9 alone will not solve Puerto Rico's situation, and added the right approach includes a thorough analysis of the internal factors that led the island into its current fiscal issues. In every type of bankruptcy case, whether it is corporations, consumers, or municipalities, structural reforms have to be coupled with bankruptcy to help solve whatever problems got the debtor into insolvency in the first place, he said.

Puerto Rico's Gov. Alejandro García Padilla and a group of island officials created a fiscal growth plan for the island that the commonwealth's legislature is currently considering.

While Rhodes did not comment on the specifics of the plan, he said it is an example of the kind of steps Puerto Rico needs to think about to get back to where it wants to be.

"There has to be a complete top to bottom review of everything the island does, from water to electricity to tourism to manufacturing to shipping and see where efficiencies can be obtained and where the opportunities are and pursue them with vigor," Rhodes said.

"That is exactly what Detroit and its emergency manager did and it's working," he added, referring to the debt adjustment and revitalization plan Detroit pursued.

Also similarly to Detroit, Puerto Rico's leaders will have to balance paying back the debt and providing citizens with essential services, he said.

García Padilla has already said he will choose Puerto Ricans over the creditors if the choice presents itself.

Rhodes used the essential service needs to balance those competing interests as another argument for a bankruptcy solution.

"The advantage of bankruptcy is that people will still continue to get their police, their fire, their emergency medical, their roads, their educations, their power, their water, even though the defaults are taking place," he said.

As Puerto Rico inches closer to what García Padilla and others have told observers will ultimately be a series of defaults on its outstanding debt, Rhodes said lawmakers can still make a difference by passing bankruptcy legislation, even if it comes after the commonwealth has already started defaulting.

Puerto Rico is expected to default on some of its debt by Dec. 1. The likeliest payment to default is the $355 million obligation in notes the commonwealth's Government Development Bank has due on that date, according to a recent report by Moody's Investors Service.

"Does there come a time when bankruptcy can't help? I don't think so," Rhodes said. "The conventional wisdom is that the longer an entity that is insolvent waits to file bankruptcy, the more challenging and more expensive the bankruptcy becomes."

by Jack Casey

Rhodes: Bankruptcy Critical for All of Puerto Rico