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Puerto Rico is proving to be something of a case study for how politicians and bureaucrats, when finally faced with the consequences of their excessive spending as they run out of money to pay the debts they racked up to sustain it, will engage in even more unethical conduct to escape them.
In today’s example, that means bad faith negotiations with the government’s creditors. Here, on Wednesday, October 21, 2015, Puerto Rico’s Government Development Bank (GDB), which is fully owned by the Commonwealth of Puerto Rico and is therefore the government’s primary representative in dealing with Puerto Rico’s creditors, broke off negotiations on restructuring the government’s debt with them.
In breaking off those debt restructuring negotiations at this time, the GCB is effectively seeking to increase the risk that the government defaulting on its upcoming debt payments, in an attempt to force the creditors to take larger losses on the loans they made to Puerto Rico, through bonds issued by the GCB, by deliberately driving down their value.
Barron’s describes the details of the current negotiations.
The big problem, John Miller, who runs municipal bond investing at Nuveen Asset Management, told Barron’s, is that GDB owes a more than $350 million payment to creditors Dec. 1 and is unlikely to be able to pay it without the liquidity a debt restructuring could provide. Puerto Rico has said it will run out of cash in November.
Miller says GDB debt is backed by the government and considered to have nearly as strong guarantees as government obligation (GO) debt. If Puerto Rico can’t make payments on the GDB debt, it probably won’t be able to make payments on the bigger chunk of GO debt it owes either.
“A lot of investors said that the government can’t default on the GO debt because it is constitutionally protected,” Miller said. “But Constitutional protection can’t prevent Puerto Rico from defaulting if it is running out of money.”
However, there is still more than a month to go until the tell-tale GDB payment is due.
Walking away from the table will likely cause the GDB debt to fall in price, which could influence negotiations, points out Miller. Investors may be willing to accept worse terms for an exchange when the bonds are falling in price. Nuveen, which manages $105 billion in munis, has only about $300 million in insured Puerto Rico bonds, mostly in in state specific closed-end funds.
Here’s how Unilex, a database on international case law, describes bad faith negotiations:
(1) A party is free to negotiate and is not liable for failure to reach an agreement.
(2) However, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party.
(3) It is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party.
Regardless of how Puerto Rico’s debt restructuring negotiations play out, the GCB’s bad faith conduct in this case is very likely to prompt future litigation, as the creditors harmed by the GCB’s action will be able to demonstrate losses resulting from its bad faith conduct. In turn, that means that the people of Puerto Rico will be faced with even greater liabilities in the future. Unlike its debt obligations today, where it knows to the penny how much its liabilities are, the magnitude of what those additional liabilities have yet to be defined.
That Puerto Rico’s politicians and bureaucrats would seek such a remedy for what ails it confirms that the real causes of their current debt ailment will not ever be cured by simply restructuring their debts, as the bad faith they are demonstrating now is only the latest evidence of what their conduct has been all along. It will only be when good faith prevails and the practice of sound fiscal policies returns that the territory’s fortunes might change for the better.