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The “McKinsey Way” in Puerto Rico

Puerto Rico’s Financial Oversight and Management Board (FOMB) is facing a number of challenges right now, from ongoing conflict with the territorial government to a legal ruling declaring the board unconstitutional. They’re relying on advice from management consulting firm McKinsey & Company. The consulting firm sees Puerto Rico’s troubles as “a management crisis brought to a head by debt.”

Puerto Rico had, according to McKinsey, “engaged in a wide variety of destructive borrowing behaviors.” Growing debt was shored up by tax tricks that washed money through Puerto Rico’s economy without providing jobs or maintaining infrastructure. Creative accounting made the budget look balanced, but gaps between income and outgo were bridged by further debt. Puerto Rico’s tax-free bonds were downgraded to junk status, and a mysterious loophole in the bankruptcy code prevented Puerto Rico from declaring bankruptcy. Some hedge funds saw that as an opportunity. “It looked,” according to The Intelligencer, “as if the bondholders could seize tax revenues or assets belonging to the island and no one could stop them.”

It was like a game of hot potato, and bondholders left holding the spud saw aggressive pursuit of their payments as their best solution. Puerto Rico’s governor stated simply that Puerto Rico could not pay the debt, and the territory defaulted.

President Obama and Congress came up with a law called PROMESA that created a Financial Oversight and Management Board (FOMB) to help Puerto Rico restructure debts and get better fiscal control. Bondholders lobbied against PROMESA and Puerto Rico leaders generally supported it at the time. The board hired McKinsey, and the consultants got to work identifying cost-cutting opportunities for the Island.

The McKinsey Way, a term used by the firm and also the title of a book detailing the organization’s philosophy, refers to the use of hard data to create hypotheses about how to solve problems. Puerto Rico had limited data about its resources and expenditures, and the consultants started by drilling into the records in every office.

The Intelligencer suggests that hiring consultants allowed the board to avoid hiring a staff which might look like a parallel government. Instead, teams of short-term consultants with varying backgrounds provide expertise designed to reduce expenses.

With a focus on austerity for Puerto Rico rather than reducing obligations to creditors, the FOMB and McKinsey met with resistance from leaders and residents in Puerto Rico. McKinsey has holdings of at least $20 million in Puerto Rico bonds through a subsidiary. An independent investigation held that the investment is separate from the consulting company, which is expected to receive a large chunk of the $1.5 billion the Island is spending on consultants to help them through the debt crisis.

The House Natural Resources Committee will hold a hearing this week on the austerity measures being imposed by the FMOB.

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