Here's Bernie Sanders' Plan To Save Puerto Rico And Stick It To Vulture Funds

His new bill would put the island's economy ahead of vulture fund profits.
MOLLY RILEY via Getty Images

WASHINGTON -- Puerto Rico's economy has been in a depression for a decade. With the territory likely to default on a $2 billion debt payment on July 1, the island's ugly humanitarian situation could become even more nightmarish.

More than half of Puerto Rican children already live in poverty, its unemployment rate is over 12 percent and the government has been closing schools and curbing public services to help make short-term debt payments. On Monday, the U.S. Supreme Court ruled that Puerto Rico is barred from requiring vulture funds -- those that invest in distressed debt -- to take haircuts on government bonds. The ruling grants the federal government exclusive jurisdiction over any debt reduction scheme for the U.S. territory. Wall Street hedge funds were thrilled.

But the July 1 deadline and the Supreme Court ruling also strengthen the hands of Washington politicians -- including those more enamored with traditional thinking at the International Monetary Fund than with the concerns of American citizens living in Puerto Rico.

Thus far, there have been two positions on resolving the Puerto Rican crisis circling through the nation's capital. Vulture funds have pursued a "screw you, pay me" strategy that has gained traction with many congressional Republicans, while decimating Puerto Rico's economy. The Obama administration, by contrast, has backed a bipartisan bill to impose further budgetary austerity on the island, coupled with meaningful debt reduction. The bill's austerity intent is clear. It would allow for the minimum wage to be suspended, and would lift President Barack Obama's new overtime pay expansion island-wide. American citizens in Puerto Rico might well ask whether being stripped of labor protections provided to mainlanders is a product of the island's colonial history. It's hard to see what private-sector investment in such plans would encourage other than, say, payday lending.

The choice, in other words, is between madness and masochism. So, late last week, Sen. Bernie Sanders (I-Vt.) quietly unveiled an alternative. Sanders would cut vulture fund investors out of any benefits from a debt-reduction deal, while establishing a long-term infrastructure plan to fix the root problem of Puerto Rico's debt: a dysfunctional local economy.

The Sanders bill faces major political headwinds. While Obama's strategy has cleared the House, the executive branch is all but begging the Senate to vote on it in time to avert a July 1 debacle. And Sanders is not exactly an ideological ally of Senate Majority Leader Mitch McConnell (R-Ky.), whose support will be needed to pass any law to salvage the Puerto Rico situation. But the Sanders bill is a clever approach to a problem that could upend traditional thinking on financial crisis management around the world -- one that prioritizes the well-being of Puerto Ricans over Wall Street profits.

Obama and House Speaker Paul Ryan (R-Wis.) have blessed The Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA, which Sanders has savaged on the presidential campaign trail. PROMESA would set up a new Washington-appointed oversight board empowered to direct spending and taxation plans for Puerto Rico, and, if all goes well, reduce the the island's overall debt levels.

Economists have been all but screaming for a reduction in Puerto Rico's debt for years, and PROMESA marks the first actual attempt to maybe, eventually do something about it. But there are obvious drawbacks to the bill's approach. PROMESA is unpopular on the island, and has been sharply criticized by the territory's governor and and major candidates vying to succeed him. Working out and implementing debt relief may simply prove politically unworkable. Even if the oversight board can impose a plan, the vulture funds that inflamed the island's humanitarian crisis could end up profiting handsomely from it.

As Puerto Rico's fiscal situation deteriorated, a lot of investors dumped their bonds at deep discounts, hoping to salvage some of their money instead of losing much more if the island defaulted. But hedge funds that bought up debt at a 20 or 30 cents on the dollar have been driving Puerto Rico's politics ever since, refusing to negotiate with the local government and demanding full payment as the economy falls apart. Since these vulture funds bought the debt on the cheap, even a deal that substantially reduces the face value of their debt could reward them for holding the island financially hostage.

Sanders would set up a new government bank empowered to buy up Puerto Rican debt at whatever price bondholders actually paid for it. For early investors who held onto their bonds, including many pension funds, that's clearly a bailout. But it also means zero profit from the "screw you, pay me" strategy the vulture funds have pursued. They only get whatever they paid for the debt. The Sanders bill also would allow Puerto Rico to write off debts in bankruptcy -- a right afforded to U.S. states.

The Sanders plan obviously entails some level of moral hazard. Investing isn't supposed to be a risk-free proposition. Financial firms earn returns on their investments by shouldering the risk that they might not be repaid. Ensuring that mutual funds, pension funds and other early buyers of Puerto Rico debt continue to be paid in full would send a signal to markets: When reckless governments ask for money at high interest rates, the feds will always be behind you. That could encourage bad investment decisions and bad local government fiscal management.

But the same principle applies to the vulture funds that swooped into the Puerto Rico debt markets in recent years, hoping to use political pressure to counter the economic insanity of their bet. Letting them turn a profit on a ploy to immiserate working people and strip them of democratic power sends a pretty strong signal, too. A super-tough debt reduction plan under PROMESA, of course, could wipe out vulture fund gains. But doing so would face serious political opposition from more sympathetic actors -- the pension and mutual funds behind middle-class retirement accounts.

PROMESA is ultimately a plan to stave off an immediate calamity with the promise of potentially useful future solutions, followed by further reforms not even included in the law. Hopeful congressional staffers believe that a good PROMESA plan would give hedge funders incentives to support additional Medicaid spending in Puerto Rico and encourage Congress to make the territory eligible for the Earned Income Tax Credit -- federal payments to low-income families working in jobs that don't pay well.

More cash in thin wallets would give citizens money to spend on goods and services, which can in turn pay workers to provide more goods and services, which could ultimately boost the economy enough to make future debt payments more plausible. Poverty support, in other words, would trickle up to vulture funds.

Sanders takes a different approach. Instead of hoping for Medicaid and Earned Income Tax Credit funds at some future date, he'd implement them now. And instead of slashing local budgets, he'd create a new federal grant program for highways, trains, ferries, broadband, renewable energy and housing. Improving the basic services of the local economy, the thinking goes, would encourage private-sector investment.

Republicans have resisted federal infrastructure spending for years, of course, and are unlikely to support Sanders' plan. Still, similarly ambitious initiatives have been successfully implemented in Puerto Rico. In the 1930s, President Franklin Delano Roosevelt supported an agency that pumped federal dollars into infrastructure investment in Puerto Rico, directed by local officials who understood the island's needs. Their plans helped eradicate malaria, tuberculosis and hookworm from the island, make electricity available to the island's interior and establish hurricane-proof construction using local manufacturing. Life expectancy significantly increased, according to research by Geoff Burrows, a Seton Hall University history professor.

PROMESA promises not to spend any federal tax dollars on Puerto Rico. But sometimes, you have to spend money to make money.

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