Puerto Rico's Financial Control Board Has Major Conflicts of Interest

The process of debt restructuring in Puerto Rico has been, if nothing else, an alarming case study in conflicts of interest, cronyism, and putting politics ahead of doing the right thing. As the island struggles to regain its financial footing under the heavy burden of unfunded liabilities and falling credit ratings, it would appear that some of those appointed to solve the problem are more concerned with preserving their own reputations—as well as their future political career—than with doing the job they were hired to do.

Following the model of the District of Columbia and Detroit, Puerto Rico is relying on a financial control board, operating independently of elected officials, to negotiate debt settlements with bondholders. This would be a sensible, elegant solution were it not for the fact that several members of the board have conflicts of interest that provide the wrong incentives for the island's financial future.

To understand the current mess on the island it helps to look at how Puerto Rico got into fiscal trouble in the first place. One among many mistakes made in the last decade has been the use of so-called COFINA bonds (named for their Spanish acronym) to circumvent nominal limits on debt accumulation, which allowed Puerto Rico's fiscal liabilities to become far greater than would otherwise have been possible. COFINA bonds are backed by the revenue collected from sales taxes, and are distinct from the general obligation bonds held by investors.

While Puerto Rico's constitution guarantees payment on general obligation bonds, there is no such explicit guarantee for COFINA bonds. Yet while the commonwealth was forced to default on $780 million in general obligation debt, COFINA bondholders have continued to receive on-time payments, an act which some hedge funds contend is unconstitutional. The financial control board has requested the lawsuit be stayed, in spite of a ruling by Judge Francisco Besosa that it should be allowed to proceed.

Why have COFINA bonds received better treatment than general obligation? One point that's been made is that at least two of the members serving on the financial control board have significant personal interests in COFINA bonds. Board member Carlos Garcia formerly ran Puerto Rico's Government Development Bank, the agency in charge of issuing COFINA bonds. He played a central role in creating the COFINA bond system in the first place, and under his leadership the bank issued just over $9 billion in bonds, which constitutes more than half of the total COFINA debt outstanding. Furthermore, Garcia has ties to Santander Bank, for which he was once president and CEO. The bank currently holds $118 million in COFINA obligations.