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Treasury Dept. Plays Tricks with Puerto Rico Debt

Walter Russell Mead

Obama administration Treasury officials want to discriminate against holders of Puerto Rico’s general obligation bonds and give retired public employees a better deal as the island’s debt mountain collapses. Mary Williams Walsh reports at the New York Times:

A broad plan being put forward by the Treasury Department to ease Puerto Rico’s financial crisis would put pension payments to retirees ahead of payments to bondholders — a move that some experts fear could rattle the larger municipal bond market.

The proposal was being driven by evidence that Puerto Rico’s pension system is nearly out of money, leaving retirees who are dependent on it financially vulnerable.

The impulse to aid Puerto Rico’s civil servants is understandable and the idea is well-intentioned, but this plan is seriously misguided. General obligation bondholders bought Puerto Rico debt under a clear and transparent set of rules—that these were senior obligations taking priority over everything else. Meanwhile, grotesquely incompetent and venal politicians promised generous pensions to civil service employees without making sufficient provision to cover those pensions when the bills came due. Now, sure enough, the territory doesn’t have the money to cover its pension obligations, or to pay back the money it borrowed from bondholders.

The Treasury seems to have decided that the best way to handle this mess is to play tricks—to decide which group of debt holders is most “morally worthy,” and to give that group the first claim on the island government’s resources regardless of contractual obligations. There’s a good argument for helping out pensioners, many of whom are now too old to go back to work, and who in any case played by the rules and did their jobs. But, as Walsh notes, it isn’t so simple. Many of the people who own Puerto Rico general obligation bonds are themselves old, retired people on limited incomes who bought these investments on the promise that they would be the first debts to be repaid. So who has the better claim: The retired teacher in New York who bought Puerto Rico bonds or the retired teacher in Puerto Rico who has a pension from the system?

Worse still, as investors everywhere realize that the U.S. government no longer thinks that enforcing the law of contract is a sacred trust and obligation—choosing instead to privilege some groups of debt holders and punishing others based on the perceived moral or political standing of each group—the value of all municipal debt in this country will fall. Cities and states will have to pay more to borrow money once bondholders realize that they can’t trust the fine print. That means fewer new schools, fewer public services, fewer repairs to bridges and tunnels, fewer mass transit projects, dirtier parks, and less safe streets all over the country.

The right course of action in this case is crystal clear: The debts should be paid (or not paid) in accordance with the terms under which they were incurred. If Congress decides that pensioners need and deserve additional relief, and there is a good case that they do, let it appropriate funds directly to help these people. Hiding the cost of pension fund relief by giving money that belongs to one group of claimants to another group based on arbitrary moral considerations is shady, dishonest, and ultimately futile.

Moreover, in dealing with this situation, Congress needs to understand that Puerto Rico, while unique in some respects due to its legal status as a territory, isn’t the first and probably won’t be the last of the major blue bankruptcies coming down the pike. We cannot bail out the “nice” claimants and punish the “bad” ones without damaging the national credit and eroding the rule of law. The U.S. government may well have to step in and offer relief to retirees, on both humanitarian and pragmatic grounds. And we must bear in mind that however these debt issues are settled, the citizens of these cities, states, and territories have legitimate claims on government services. We can’t close the schools to pay pensions to retired teachers.

But at the same time, we can’t permit the reckless incompetence of decadent blue model governance to rage on unchecked, piling up more unpayable debts, putting communities at risk, and placing escalating demands on the federal budget. Relief, yes, and generous relief where warranted—but the price of bailout must be real reform.

In the meantime, Congress needs to hold hearings on fiscal mismanagement by local governments, not only in Puerto Rico but also in U.S. cities like Stockton and Flint. It should also be looking into public pension programs in states like New York and cities like Chicago, and developing, among other things, legislation that subjects public pension systems to tough regulation to make sure that, come what may, the claims of retirees will be protected.

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