Michelle Ye Hee Lee

“Small investors like Teresa own 80 percent of Puerto Rico’s debt. … This is a bailout of Puerto Rico on the backs of savers like Teresa. Congress wants to bail out Puerto Rico with Teresa’s retirement savings.”

–political ad by Center for Individual Freedom

The Center for Individual Freedom is a 501(c)(4) “dark money” group that has purchased at least $200,000 in national ads opposing Congress’s debt relief plan for Puerto Rico. The ads characterize the debt plan as a “bailout” on the “backs of savers,” like a woman named Teresa Garcia featured in the ad. (We spotted this ad on the Political TV Ad Archive, our partner for tracking primary election ads.)

Congress is expected to take up its Puerto Rican debt relief plan as it returns from recess this week. Is this plan a “bailout of Puerto Rico on the backs of savers”?

The Facts

The island U.S. territory of Puerto Rico owes more than $70 billion, due to a decade-long economic recession caused by several factors. The government borrowed a lot of money to cover its budget shortfalls, and now the government owes so much that it can’t repay its debts by raising taxes or cutting spending. Its governor has declared a humanitarian crisis, as Puerto Rico is running out of cash to fund core public services. Puerto Rico already has defaulted on hundreds of millions of dollars in payments, and its next payment is due July 1.

As a U.S. territory, Puerto Rico can’t declare bankruptcy or restructure its own debt like states or municipalities can under Chapter 9 of the U.S. Bankruptcy Code. Instead, Congress has broad authority over the territory’s public financing.

H.R. 4900, the Puerto Rico Oversight, Management and Economic Stability Act, was introduced in the House in April to establish an oversight board to help Puerto Rico manage the crisis. This oversight board would be similar to one that Congress established in the mid-1990s to help guide Washington, D.C., through a financial woes. House Speaker Paul D. Ryan is pushing for the bill, crafted by the House Natural Resources Committee.

Puerto Rican municipal bonds offer generous tax exemptions. Bonds sold to Puerto Rican residents are not taxable in Puerto Rico. Bonds sold to investors in the mainland United States have triple-tax exemption (federal, state and local).

Teresa Garcia is a Puerto Rican resident who in 2005  invested about $500,000 of her retirement savings in Puerto Rican bonds, to complement her Social Security retirement benefits. Her broker told her that investing in general obligation bonds, issued by the government and constitutionally protected, would allow her to take advantage of a tax exception on capital gains.

“We understood that it was a good investment,” Garcia told The Fact Checker. “So we decided to invest most of our money in Puerto Rican bonds.”

Garcia estimated that 80 percent of her retirement savings were in the bonds. She said she lost about half of her investment since 2013, and worries her interest payments–which have continued uninterrupted–will be reduced as a result of the debt crisis and debt restructuring proposed in the legislation. Puerto Rican general obligation bond rating was downgraded in 2014 to junk status.

By the calculation cited in the ad, individual direct bonds owned by Puerto Ricans like Garcia comprise about 20 percent of the debt. The ad cites Puerto Rico’s El Nuevo Dia, which compiled data and interviews to show that about 80 percent of the debt is held by Puerto Ricans (19.4 percent), individual investors from mainland U.S. (29 percent) and mutual funds (32 percent).

Mutual-fund investors face less of a risk because the Puerto Rican bonds make up only a portion of the overall portfolio.

In recent years, the investor base of Puerto Rican securities shifted to hedge funds from traditional mutual funds, according John Miller, managing director of Nuveen Asset Management, who testified in Congress on the debt relief plan. Less than 50 percent of mutual funds owned some Puerto Rican securities in 2015, a decline from 75 percent in 2013. So this shift means there is less risk to retail investors, Miller said.

Is it a “bailout”? Not in the sense that most people have come to understand a government bailout, such as rescues of the bank and auto industries during the economic recession. The legislation doesn’t appropriate any taxpayer dollars to Puerto Rico. Instead, a control board would oversee court-ordered restructuring, and conduct a financial audit. A judge would ultimately have power to reduce the island’s public debt.

Still, opponents say it’s essentially a bailout, and that Congress is changing rules to allow Puerto Rico to pay less to some creditors. They say it’s Chapter 9 bankruptcy applied retroactively, because it applies elements of the U.S. Bankruptcy Code. The bill also would “halt most creditors’ lawsuits against Puerto Rico, another provision that is normally available only in bankruptcy,” according to the New York Times.

Dark money groups are not required to disclose their donors, so it’s not clear who is backing this national campaign. But there is “widespread belief on Capitol Hill that the group is acting at the behest of those bondholders opposed to a court or board-imposed restructuring,” reported our Washington Post colleagues.

The Center for Individual Freedom pointed us to a statement defending its use of the term “bailout,” and said that in its ads, it never said the “bailout” would be directly funded by American taxpayers:

“What we have said is that H.R. 4900 is a bailout directly on the backs of individual investors and retirees in Puerto Rico and across the United States who own Puerto Rican bonds in mutual funds or other investment accounts. A large majority of Puerto Rico’s public debt is held by such investors who will pay dearly for legislation that does not respect their legal rights. … And despite claims to the contrary, we have never advocated that Congress turn a blind eye to the crisis by doing nothing.”

Is this plan “on the backs of” individual Americans? If the bill passes and Puerto Rico restructures its debt, individual creditors likely will get a lower return on their investment. Someone who has a general obligation bond and interest payment due in June for $500 might end up getting $200. The remaining $300 would go toward basic services for the island, said Frank Shafroth, who researches municipal bankruptcies and is director of George Mason University’s Center for State and Local Government Leadership.

Outcomes from other cities that defaulted on their debts — like Detroit and Stockton, Calif. — showed that even general-obligation bondholders may not fully recover. Municipal bondholders did not receive what they were promised and owed under the respective debt adjustment plans, Shafroth said.

But every day that a solution is delayed, residents are losing out on more money. Without an oversight board, creditors would resort to a years-long legal battle that may result in even lower returns after legal fees. And, if Puerto Rico continues to lose cash, it jeopardizes basic services for seniors and other residents like Garcia.

Plus, the legislation has a “best interests of creditors” test so that stakeholders — including retirees and secured bondholders — are treated fairly based on their respective legal rights. “Moreover, I suspect it will be less of a recovery in Puerto Rico, because with each day that passes without a resolution now, the revenue bleeding is leaving less and less fiscal resources,” Shafroth said.

The Pinocchio Test

The ad creates the impression that Congress’s debt relief plan would use the savings of individual small investors to bail out Puerto Rico. But in reality, the bill doesn’t actually appropriate money to “bail out” Puerto Rico. It aims to create an oversight board to restructure Puerto Rican debt, and gives a judge the power to reduce the island’s debt.

There indeed are people like Teresa Garcia, who bought municipal bonds–and they would almost certainly be paid less than they are owed. The Center for Individual Freedom said it “never said in any of its television or radio advertisements that the PROMESA [legislation] ‘bailout’ would be funded directly by American taxpayers.” But rather, the group argues that the “bailout” is “directly on the backs of individual investors and retirees.”

But that seems like a semantics game. Ultimately, the ad misleads the public to make it seem as if the legislation would only hurt individual bondholders. People like Garcia likely will get a lower return on their investment after the restructuring, but such investors are a much smaller portion of the holders than 80 percent. Moreover delaying a restructuring — or resorting to a default — likely leads to worse circumstances for ordinary bondholders.

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