Meet the Legal Theorists Behind the Financial Takeover of Puerto Rico
Two lawyers argue that the feds should impose “dictatorships for democracy” on cities and government bodies in fiscal crisis.
By Simon Davis-Cohen
A urse dispatched to Puerto Rico by the Registered Nurse Response Network described the island’s dire situation earlier this month. “A line formed outside FEMA in Rio Grande two nights ago,” she wrote in a public letter. “People waited 24 hours only to receive 1 16oz water and one snack size Cheez-it’s. The people of Puerto Rico are starving and have no access to water.… They have turned off the water and we are running out of bottled water.”
A humanitarian catastrophe is unfolding, and the federal government urgently needs to fund public services, transportation, and basic goods. But, rather than provide the money as aid, Congress approved a $5 billion loan, which will only add to the island’s immense debt. On top of that, Puerto Rico has little say over how it will be rebuilt. In 2016, the federal government appointed a seven-person Federal Oversight and Management Board (FOMB) to restructure the island’s debt, with the belief that the US territory needed sweeping cuts. Austerity, exacerbated by the FOMB, had already deteriorated the quality of life, but the ravages of Hurricane Maria have made local control and additional spending critical. Instead, hands tied, the island’s elected governor has been reduced to nonprofit fundraising.
Puerto Rico should be a cautionary tale for the mainland United States. The legal theories that have been applied to Puerto Rico also undergird the “emergency management” of cities like Detroit, Flint, and Atlantic City, where elected local governments have been suspended in favor of financial overseers tasked with imposing regimes of economic austerity.
At the root of this antidemocratic approach is the idea that the elected government in any given crisis is to blame for the economic distress. As Puerto Rico’s financial situation worsened in 2016, a dominant narrative emerged that it was corruption—and not population decline, poverty, and the federal government’s role in encouraging Puerto Rico’s debt (by allowing people to lend money to the island without paying any taxes)—that caused the problems. And if a government is unable or unwilling to pass the kind of tough policies needed to help its constituents in a fiscal emergency, then suspending it becomes justified.
This paradigm of austerity-based intervention is supported by a growing body of legal and economic theory. In 2014, Clayton Gillette of New York University Law and David Skeel Jr. of University of Pennsylvania Law began drafting a transformative legal argument about municipal bankruptcies. The paper was published in 2016 in The Yale Law Journal, under the title: “Governance Reform and the Judicial Role in Municipal Bankruptcy.” It sounds dry, but its implications are far-reaching.
In the piece, the lawyers rigorously defend the legal theory that municipal governments ought to be treated like private corporations when they go bankrupt. To Skeel and Gillette, local governments and private corporations share many similarities. Both, they write, are “vehicles for providing goods and services.” Skeel told me by phone that one of the key questions they explore in their work is, “To what extent is it appropriate to use the kinds of processes used for private entities, when you’re talking about a public entity?”
When a private corporation goes bankrupt, judges can make permanent reforms to the corporation’s governing structure. A prime example is what happened to Chrysler, whose board of directors was reorganized by a judge during its 2009 bankruptcy. But judges don’t have the same power to restructure bankrupt cities and towns. “No plan of adjustment has ever granted the creditors a seat on the city council,” Skeel and Gillette write in their journal article.
They argue that because creditors cannot “dislodge the current governance structure” during times of fiscal crisis, judges should be given expanded powers to remedy “the underlying causes.” Skeel and Gillette offer judges, financial overseers, and politicians a new language that they can use; pensioners become “shareholders” of the local government, and are treated the same as profit-motivated creditors.
Gillette, who provided pro bono advice to Detroit’s emergency manager, told me there is ample evidence to suggest that certain governmental reforms “enhance the fiscal stability” of cities. Gillette said cities might consider granting mayors broad veto powers; institute at-large, rather than district-based, representation on city councils; and require multiyear budgeting to constrict public officials’ spending powers. But of course, these types of reforms are either highly controversial or would never be passed by elected officials.
This is where their central argument comes into play. “One plausible technical solution to the obstacle of popular consent,” they write, is to allow bankrupt municipalities (or their emergency managers) to make structural changes to the structure of government, without the customary referendum process. They recognize that this “is aggressive (and perhaps normatively objectionable).”
The two legal thinkers know their ideas are unpopular, but that doesn’t change their belief that temporary periods of “dictatorship” are often necessary. “There are democracy issues,” Skeel told me, “but the case for [using a control board to institute government reforms]…is that when a public entity is in deep financial distress there is almost always some government dysfunction connected with it.”
The intervention of an oversight board, he continued, “can sometimes catalyze reform that makes the entity more democratic and responsive…but you go through a process that is not democratic, there’s no question about that.”
Gillette wrote another essay in 2014 titled “Dictatorships for Democracy: Takeovers of Financially Failed Cities,” which advocates dictatura rei gerundae causa, or “the dictatorship for getting things done.” He argues that takeover boards should be allowed “to exceed the limits of the Roman dictator, who was [allowed to take control during crises but] prohibited from making changes to the constitutional structure of the republic.”
As Gillette explained to me, “A financial-control board can sometimes do things that are either politically unpopular with important groups or that constrain political officials, which elected political officials would never push for, even though there are positive effects for the residents of the municipality as a whole. So, is that antidemocratic? Well, define ‘democratic.’”
Even laying aside the undemocratic nature of oversight boards, the solutions they impose on populations are often painful and ineffective. Just ask anyone in Flint. According to local-government expert Michelle Wilde Anderson of Stanford University Law, when fiscal problems are caused by chronic poverty, population decline, and the federal government’s encouragement of debt, the situation won’t be fixed “with better spreadsheets or fiscal tools.” If a household isn’t bringing in enough money because of a job loss or injury, Anderson told me, “you can’t tell them they need better financial management.… If it’s a revenue problem, what they need is a living-wage job, not a financial expert to prohibit them from buying groceries.”
In struggling cities in Michigan and Pennsylvania, Anderson said, many expert financial managers “got in there and saw the revenue collapse, and there was nothing they could do about it. They don’t have new funding or special tools to bring the city’s people out of poverty. And so they get the hell out of there in a few years, leaving the city no better off than it was before.”
When poverty, postindustrial decline, and population loss (or a hurricane) are the sources of economic crisis, you can’t blame the government, and therefore suspending it becomes less justified. While Anderson is quick to say she is not “against the notion of takeover laws full stop,” she thinks control boards should not be given powers superior to those of an elected official: “We have to give the electeds all the tools that we think are needed to keep a city’s budget balanced.”
Gillette, on the other hand, suggests, in “Dictatorships for Democracy,” that lack of results from control boards is likely because they have failed to use the opportunity of what he calls “extraordinary politics, or dictatorship,” to make permanent structural changes. A solution, he argues, may be to “deploy the most controversial, nondemocratic characteristic of restructuring local government.” This, he acknowledges, “implies a very broad and autocratic use of takeover board authority.”
In 2015, Gillette and Skeel co-authored an op-ed in The New York Times calling on the federal government to create a “control board” with “serious teeth” to govern Puerto Rico’s finances. In the op-ed, they point to New York State’s 1975 appointment of a financial-control board to oversee New York City’s finances and Michigan’s use of “emergency management” to suspend Detroit’s local government in 2013 as precedents to inform the federal governments’ approach to fiscally distressed Puerto Rico. There was nothing stopping the federal government from doing something similar in Puerto Rico, they argued.
Because Puerto Rico is a “territory,” Skeel and Gillette’s 2015 Times op-ed is accurate. Just as states can unilaterally intervene to suspend municipal democratic control in Michigan, New Jersey, New York, Connecticut, Rhode Island, and elsewhere, so too can the federal government in Puerto Rico.
Nine months later, Obama signed the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA, which effectively removed the financial powers of the Puerto Rican government and the autonomy of its 78 municipalities. Two months after that, Skeel himself was appointed to serve on the Federal Oversight and Management Board. “I probably would have tinkered with a few things,” Skeel told me, referring to the design of the fiscal-control board, “but what they did looks quite a bit like what we were proposing.”
The two of them followed the op-ed with a 2016 paper further detailing their vision for a control board and “fiscal and political restructuring” in Puerto Rico. The effect of financial oversight after Hurricane Maria is that the elected Puerto Rican government can neither spend money to revitalize the island’s public services nor can it provide basic disaster recovery or a rigorous jobs program without the board’s approval.
“Maria changes everything,” Skeel told me, repeatedly. The FOMB announced that Maria would force them to revise their financial plan for the island. Tax revenues are not coming in, Skeel said, “and expenses have not disappeared.” Borrowing money would be “very difficult. The money will run out if there’s no money from Washington.”
But a control board was not the only debt-restructuring tool Skeel and Gillette supported. They also wrote an amicus curiae brief in defense of Puerto Rico’s 2014 Recovery Act, which would have given the island’s municipalities and other government bodies access to US bankruptcy-like proceedings to restructure their debt. The law was eventually struck down by the US Supreme Court after creditors challenged the law.
Their defense of Puerto Rico’s 2014 Recovery Act was in opposition to hedge funds, who wanted to be repaid in full. The fiscal-control board has also upset many of the island’s creditors for similar reasons. According to an analysis by Kate Aronoff, before Hurricane Maria the board developed a plan that would wipe out 79 percent of the territory’s annual debt payments.
But it’s not just creditors whom the board has dismayed. Cuts to the public-education system, the appointment of an “emergency manager” to control the electric grid, talks of furloughs and pension reforms, and the financial-control board’s vote to approve the wind down of Puerto Rico’s Government Development Bank (GDB) have all drawn scorn from locals. Though the GDB has a past checkered with accusations of clientelism and irresponsible debt issuances, it was nonetheless the “financial nerve center” of the island, providing key financial services to the island’s cities and government agencies.
According to a lawsuit brought by the city of San Juan, the way the GDB is being dismantled disempowers local governments by lumping them in with the rest of the bank’s creditors. The municipalities—given one vote each—are being outvoted. As a result, millions of dollars of municipal-tax revenue that the GDB held in trust will be taken from the municipalities “to pay all of GDB’s creditors, including public bondholders,” according to the San Juan lawsuit. That is bad news for cities responsible for providing medical care and policing. Last month, a federal judge denied San Juan’s effort to stop the GDB’s restructuring.
The result of this is similar to the effects of a law in Rhode Island that Gillette highlighted in “Dictatorships for Democracy.” Passed in response to the municipal bankruptcy of Central Falls, the legislation required cities to impose taxes to pay off bond holders directly—circumventing pensions and public services. “What it does is it creates what’s called a ‘first link lien,’” Gillette said, “so before those tax revenues can be used for other purposes, the creditors have a first claim on them. And the result of that in Central Falls, was that the bond holders did not get a haircut, and the pensioners got a severe haircut.”
Gillette told me, “Puerto Rico’s municipalities are facing the same issues that confront cities [on the mainland].” And Melissa Mays, Flint resident and founder of the group Water You Fighting For?, agrees. “The most glaring [similarity],” Mays wrote in an e-mail, “is that poor people are blamed for their own situation. In Flint, they tried to blame the careless water switch on Flint residents because we supposedly didn’t have enough money to pay our water bills.… In Puerto Rico, they’re trying to say that they were worse off before the hurricane, because they were so poor, and it’s their fault that they do not have better disaster resources.”
Hurricane Maria should be an existential crisis for Puerto Rico’s FOMB. The unfolding crisis can no longer be pinned on Puerto Rico’s government. The argument justifying the FOMB’s existence has disappeared. Meanwhile, residents fill the vacuum left by the government. Mays said, “You have the poor and poisoned in both disasters taking care of the poor and poisoned because the government refuses to.… The more democracy we lose, the more lives are lost.”
* Simon Davis-CohenSimon Davis-Cohen is a journalist and editor of the Ear to the Ground newsletter, an exclusive “civic intelligence” service that mines local newspapers and state legislatures from across the country.