The legal brawl over Puerto Rico’s bankruptcy begins this week, and it will be long and ugly. The pain might be worth something if the island can use this rare chance to reform its government, and creditors learn a hard lesson about lending to spendthrift politicians.
After San Juan said last year that it couldn’t repay its debts, Congress passed a law known as Promesa that created a seven-member federal oversight board modelled on the one that turned around Washington, D.C. in the 1990s. The board rejected the first two fiscal plans proposed by former governor Alejandro Garcia Padilla and his successor Governor Ricky Rossello before accepting a third.
But even that plan couldn’t prevent a debt restructuring after Mr. Rossello and creditors failed to agree on a voluntary plan. The creditors are now crying foul, claiming that the control board intervened to scuttle the talks. But the board says Promesa’s Title III bankruptcy process to reduce the debt was all but inevitable, and mutual funds could face losses as high as $5.4 billion in what are likely to be court-directed haircuts.