Why is a bankrupt Puerto Rico spending more than a billion dollars on expert advice?


The full title of this fascinating—and, for me, gut-wrenching—article by Andrew Rice (in collaboration with Luis Valentín Ortiz and Centro de Periodismo Investigativo) is “The McKinsey Way to Save an Island. Why is a bankrupt Puerto Rico spending more than a billion dollars on expert advice?” [Many thanks to Roselina Rivera for bringing this item to our attention.] Here are a few excerpts; please, read the full article at Intelligencer.

Since 2016, Puerto Rico has been buffeted by a natural disaster and several overlapping, man-made catastrophes. Its government is bankrupt and owes $74 billion to bondholders: a staggering sum that amounts to 99 percent of the island’s gross national product, or $25,000 for each of its 3 million men, women, and children. It faces a vociferously hostile president, a stalemated and colonial relationship with Congress, entrenched local political dysfunction, and a bunch of angry creditors — most notably, a group of hedge funds that speculate in distressed debt and are fighting for every last penny they think they’re owed.

“I mean, it’s basically a management crisis,” Bertil Chappuis said one afternoon, as we sat at a Cuban luncheonette in San Juan. “Set aside the politics. Set aside policy. Set aside all of that. There was a true management crisis that had come to a head because of the debt.”

Nail, meet hammer: Chappuis is a senior partner at McKinsey & Company, perhaps the world’s most influential management consulting firm. McKinsey prides itself on tackling the world’s most important and intractable problem. Over its century-long existence, the firm — or “The Firm,” as its employees refer to it — has conceived and propagated many of the ideas that now rule American business, which is to say, American life. Its influence can be seen in corporate suites (a disproportionate number of Fortune 500 CEOs are ex-McKinsey consultants) and grocery stores (the bar code is a McKinsey innovation), in banks, universities, and hospitals. All the while, the firm has maintained an air of mystery, seldom disclosing the details of its works, deflecting credit when its efforts are successful, dodging blame when they blow up or inflict pain on those on the receiving end of its efficiencies.

For the last two years, though, Chappuis and the firm have taken on an unusually visible role in Puerto Rico’s contentious and very public bankruptcy process. Under a law Congress passed in 2016, the island’s finances are overseen by a federally appointed board, which hired McKinsey as its “strategic consultant.” Chappuis, in turn, is the firm’s point man. In October, the board issued a 148-page fiscal plan that touches nearly every sector of the Puerto Rican government. Following McKinsey’s guidance, it laid out numerous service reductions, agency consolidations, and “right-sizing” measures — the plan’s euphemism for job cuts.

“This is a historic opportunity to actually reset the game here,” Chappuis declared when we first met in mid-January. Raised in San Juan, he is tall and dark-haired with a regal bearing. His background is in internet technology, and he has scant experience dealing with a governance problem on the scale of Puerto Rico’s. He has never worked as an elected official or a bureaucrat or an economist (but he leads a team of consultants who do have such expertise). What he does possess is an infectious enthusiasm for management science — the much-chronicled “McKinsey Way.” His optimism is unwavering, even as his work and the firm’s role in Puerto Rico seemed imperiled.

The day after we had coffee, public employees would protest outside the federal courthouse, where the island’s bankruptcy case was being heard. Leaders of police unions were blaming a wave of murders on budget cuts and mismanagement. The critics of the oversight board — or la junta de control, as it is called by people in Puerto Rico who say its powers far exceed oversight — decry both the impact of the cuts and the fact that much of the resulting savings would go to repay creditors, including the hedge funds, many of which bought bonds at a deep discount after Puerto Rico defaulted on its debts.

In D.C., Democrats like presidential candidate Elizabeth Warren were excoriating McKinsey for having “paved the way for many of Puerto Rico’s creditors to receive handsome payouts.” Meanwhile, the Trump administration was maneuvering to cut federal disaster aid to the financially fragile island, a campaign that culminated in April with a Twitter tantrum accusing Puerto Rico’s “grossly incompetent” elected leaders of “foolishly or corruptly” spending the money the territory had already received. Democrats and Republicans in Congress are currently at loggerheads about how much, or how little, relief to offer.

As if that weren’t enough, McKinsey’s involvement in Puerto Rico was complicated by … McKinsey. Over the past year, the firm’s once unimpeachable reputation has been tainted by disclosures stemming from a series of lawsuits and newspaper investigations that reveal its intimate links to bad businesses (the pharmaceutical company that popularized opioids), bad policies (Trump’s immigration crackdown), and bad people (Saudi Arabia’s allegedly murderous Prince Mohammed bin Salman). McKinsey’s core company value, its loyalty to its clients, has been called into question by allegations of double-dealing. Last fall, the New York Times reported that McKinsey had millions invested in Puerto Rican bonds via the firm’s secretive internal hedge fund. McKinsey denied any conflict of interest, saying it was a routine investment that its consultants on the island were unaware of, but at the least the revelations gave McKinsey’s critics more ammunition to claim it was profiting from Puerto Rico’s misery.

Among the many mind-blowing figures in the fiscal plan, one stands out: the $1.5 billion earmarked over the next six years for costs related to the restructuring process itself — more than a billion of which will go to lawyers, bankers, and consultants, McKinsey included. (The firm billed the board more than $72 million through January, and its ongoing contracts total about $3.3 million a month.) The projected overall fees are more than five times what Detroit spent on its $20 billion bankruptcy, previously the largest local-government default in U.S. history, and higher even than the bill for Lehman Brothers, the $613 billion corporate liquidation that nearly destroyed the world economy.

All those fees are being footed by the taxpayers of Puerto Rico, which is far poorer than any U.S. state, with a median household income of less than $20,000 a year. Its economy was shrinking even before the island was devastated by Hurricane Maria, among the deadliest storms to ever hit U.S. territory. Everywhere in Puerto Rico, whether talking to community organizers or high-level government officials, I heard the refrain: “They’re treating us like guinea pigs.” And they’re right. Puerto Rico is a sort of island laboratory for an experiment in austerity. Although Detroit and a few other cities have gone bust — D.C. in the 1990s, New York in the 1970s — there is currently no legal mechanism for a U.S. state to declare bankruptcy. Yet as baby-boomers retire, many states face debt and pension obligations that may force a reckoning like Puerto Rico’s. Illinois owes $50,000 per taxpayer; New Jersey, $60,000.

[. . .] The school closings were extraordinarily unpopular. At the beginning of April, Keleher resigned under fire amid reports of an FBI investigation into her department. In an email, Keleher said the controversy surrounding her “explains a lot about why PR is in the condition it’s in,” and claimed that corruption in the department was something she had been trying to clean up. “What I’m living through is insane and destructive,” she wrote. Pesquera resigned as well shortly after he criticized budget cuts at a public hearing convened by the board. Nowhere has the hostility toward the fiscal plan been more intense, though, than at the University of Puerto Rico. “I’m an economist,” said professor Juan Lara. “I know that when you have a crisis like this, you do have to renegotiate the debt and have an austerity program. My complaint is that it’s not being done right.”

Lara questions both the depth of the cuts and where much of the projected savings are going: into the pockets of investors holding Puerto Rican bonds. “After the hurricane, it was basically taken as a given by everyone, including me, that there was going to be a very large haircut,” Lara said. But the federal judge overseeing the bankruptcy recently approved a settlement involving some $17 billion worth of bonds tied to Puerto Rico’s sales-tax revenues. The group of creditors with the strongest legal claim — many of them hedge funds — were set to get around 93 percent of their money back, less a haircut than a slight trim. (Meanwhile, a weaker group of creditors, who are mainly Puerto Rican, were likely to lose about half of their investment.) Even after the renegotiation, Lara predicted that the cost of servicing the debt would be so high that Puerto Rico would soon default again. [. . .]

For full article, see http://nymag.com/intelligencer/2019/04/mckinsey-in-puerto-rico.html

One thought on “Why is a bankrupt Puerto Rico spending more than a billion dollars on expert advice?

  1. Reblogged this on It Is What It Is and commented:
    Yes, they are … as a matter of fact, ‘THEY; always have!! … the MASTER!! … ‘“They’re treating us like guinea pigs.” And they’re right. Puerto Rico is a sort of island laboratory for an experiment in austerity.’

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