McKinsey: Doing God’s Work in Puerto Rico

A New York Magazine story by Andrew Rice, The McKinsey Way to Save an Island, pulls back the curtain on the consulting firm’s $3.3 million a month assignment for the five member oversight board that is effectively running Puerto Rico in its bankruptcy. What it reveals isn’t pretty. It shows the firm to be greedy and out of touch, confirming the picture presented by a recent alum in a Current Affairs piece, Capital’s Willing Executioners.1 And that’s not just my opinion. I sent the piece to several ex-McKinsey colleagues. All were appalled. As one put it, “I am so glad I left there before things turned so clueless and ugly.”

McKinsey is acting like a private-sector IMF, squeezing the government’s budget hard so that more payments can be made to the holders of $74 billion in Puerto Rico’s bonds. To add insult to injury, McKinsey has no meaningful experience in government restructuring yet is being paid mind-bogglingly high fees. And it’s not as if these bond investors didn’t know they were buying paper that had a high risk of default. Many were issued for the purpose of servicing outstanding debt, a red flag. Puerto Rico had also been a marketing target for interest rate swaps (the sort that burdened Jefferson County and many municipal transit authorities) and a Lehman Brothers innovation: the securitization of sales taxes…which Lehman persuaded the struggling colony to impose.

Because Puerto Rico was barred from going to bankruptcy court via Congress in 1984, when its finances became utterly unworkable, the Obama Administration sponsored the Puerto Rico Oversight Management and Economic Stability Act, which was passed by Congress in 2016. The board, widely called la junta in Puerto Rico, supercedes the elected government. It’s not only in charge of the budget but also of the negotiations with bondholders. And while it’s beyond the scope of the New York Magazine article, other coverage, particularly by Juan Gonzalez (co-host of Democracy Now! who has written extensively about Puerto Rico) and Naomi Klein, contend that PROMESA is favoring the bondholders and squeezing Puerto Rico’s citizens, who were struggling even before Hurricane Maria.

Budget-cutting to try to pay creditors is a failed strategy. If McKinsey had the expertise consistent with its fees, it should know better. The IMF’s chief economist, Olivier Blanchard, admitted in 2013 that blood-letting in weak economies was counterproductive. In econospeak, “fiscal multipliers are greater than one” which means a $1 cut in spending leads to a greater than $1 fall in GDP. That means the debt burden relative to the size of the economy rises making repayment even more difficult.

So why is McKinsey siding with creditors and bleeding Puerto Rico white? And make no mistake that that’s what’s happening. Consider this section of the New York Magazine piece:

Soon after he started the job, [gubernatorial appointee attorney Christian] Sobrino said, he met with U.S. State official Natalie] Jaresko and, via speakerphone, McKinsey consultants. They presented him with a report, “The Path Forward”; on the first page, beneath the heading “The New Normal,” were three questions:

• What are you not going to do?
• What are you going to do differently?
• How does that decision lead to savings?

The patronizing tone, Sobrino said, was typical of McKinsey, as was what followed: charts projecting an imminent budget shortfall and outlining a “right-sizing initiative.” He expressed withering scorn for the “McKinsey-bots,” his name for what he described as a constantly changing cadre of hotshots who fly into Puerto Rico for short stints and treat local officials with condescension. “I think the first phrase I heard from a McKinsey-bot was, ‘We are going to corporatize the Puerto Rican government,’ ” Sobrino said….

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….

Complaints about the fiscal plan fall into several broad — and sometimes conflicting — categories. Critics such as Sobrino concede that some cuts were necessary but object to their being imposed clumsily by unelected outsiders. Others think the plan is not transformative enough. Dentist Rafael Torregrosa lobbied in vain to persuade McKinsey to consider health options that were less reliant on private insurers. “We’re paying good money to them as consultants of la junta to push only one model,” he said, “which happens to be the worst model in health care.”

The overwhelming sentiment, though, is sheer exhaustion with austerity. After Hurricane Maria, there was an expectation that the debt would be quickly resolved, with bondholders accepting a giant reduction in what they are owed — a “haircut,” in bankruptcy terminology. Hopes for debt forgiveness were bolstered by bankruptcy expert Donald Trump. “We’re going to have to wipe that out,” the president told Fox News two weeks after the hurricane. “You can say good-bye to that.” But administration officials quickly walked back his statement, and creditors are still fighting to be paid.

“We’re just being squeezed, squeezed, squeezed,” said Luis Carlos Robles, who works for a nonprofit that serves an impoverished San Juan neighborhood. His community of 26,000 people surrounding the Caño Martín Peña — a polluted, debris-choked waterway — had absorbed a double blow. Maria left around a thousand people there homeless, while the budget cuts led to the closure of four of its eight schools and the possible cancellation of a planned government dredging-and-redevelopment program. Crime is “exploding,” Robles said, with gangs committing murders in broad daylight and victims sometimes left lying in the street for hours.

The description of the condescending meeting sounds accurate because I’ve heard complaints of McKiney’s arrogance for over two decades from search and other professionals who deal at the C-suite level. Among McKinsey’s bad habits are presumptuous sales pitches. One pattern is McKinsey consultants would meet with prospect and tell them they thought the potential client has a problem that McKinsey can solve. When the client says no (“We’ve thought about that and we don’t think it’s that big a deal because Y” or “We’re already working on it”), the consultants would get aggressive and effectively tell the client it was wrong, they really did need McKinsey.

The article includes a lot more description of the human costs of the deep budget cuts. And it mentions, early on, one reason that McKinsey might be so friendly to the vultures that are putting the screws on Puerto Rico: McKinsey, through its in-house investment arm, holds at least $20 million of Puerto Rico’s bonds. Even worse, McKinsey failed to disclose that conflict of interest at the time it pitched for the Puerto Rico assignment. Senator Elizabeth Warren and Representative Nydia M. Velázquez criticized McKinsey’s conduct and asked for more information.

The article misses that McKinsey almost certainly has an even greater commercial conflict of interest. Bankruptcy specialists work for creditors or debtors, not both. Creditors are more attractive customers because they are regularly involved in bankruptcy restructurings. McKinsey has a business incentive to favor the creditors because that’s its customer target.

McKinsey partner Bertil Chappuis, a Puerto Rican who is a technology specialist, not a government or cost-cutting expert, spoke at length to New York Magazine’s Rice. Chappuis has so little perspective on what he is saying that toads regularly hop out of his mouth. He uses the worst sort of corporate babel-speak, a predictable tell of charlatanism, of the virtues of “right sizing” and running government like a corporation.

Chappius repeatedly attributes Puerto Rico’s woes to its government, implying that having it wear McKinsey’s hair shirt would solve its economic woes. That’s misleading. Puerto Rico, as a de facto colony of the US, is even less in charge of its destiny than a US state. The article mentions in passing that Puerto Rico has to foot more of its Medicare payments than even the poorest US state because it has no Congresscritters lobbying for it. The island has also been victimized by the Jones Act, which requires that only US-flagged ships can visit its port, which results in high shipping costs, making it hard for the island to be competitive. Puerto Rico’s debt load started rising sharply when the US started phasing out tax breaks the Puerto Rico government had been able to offer with IRS approval to attract manufacturers (which due to how US pharmaceutical companies gamed the rules, meant it wasn’t a big job generator, but it wasn’t nuthin’ and provided a meaningful boost to the economy), which ended in 2006. The island took a further hit in the crisis, leading to even higher levels of borrowing.

I strongly urge you to read the entire well-researched article in full. This part gives a taste of McKinsey’s preening self-regard:

“People don’t come to work at McKinsey for the money,” Chappuis insisted, echoing a sentiment I often heard from the firm’s employees. Its entry-level salaries are generous, and its senior partners make millions, but that compensation pales in comparison to what Chappuis said he could make in, say, private equity or investment banking. “I have a team of people who are — I know the word passionate is used a lot — but we have people who are deeply, deeply committed to the work.”

I challenge McKinsey to identify a single graduating MBA who got an offer from an established private equity firm and turned it down to join the firm. Maybe McKinsey can sell that bunk to journalists who won’t challenge the idea because it’s secondary to their story line, but anyone in finance knows it’s hogwash.

Starting from when I was at the firm in the 1980s, McKinsey started losing out to Wall Street on a regularl basis and had to considerably loosen its hiring standards, going from making offers only to the top 10% of the graduating class to over time, the top 30%. Similarly, McKinsey regularly loses partners to private equity firms. It’s inconceivable that someone who was senior enough to participate in a private equity carry pool would leave that to join McKinsey.

But the more obviously bizarre part of the argument is that the public is supposed to believe that McKinsey professionals, because they claim to have left money on the table with their career choices when partners make millions are year, are somehow inherently virtuous because of that. This is awfully reminiscent of a famed Winston Churchill riposte:

Churchill: “Madam, would you sleep with me for five million pounds?”

Socialite: “My goodness, Mr. Churchill… Well, I suppose… we would have to discuss more, of course… ”

Churchill: “Would you sleep with me for five pounds?”

Socialite: “Mr. Churchill, what kind of woman do you think I am?!”

Churchill: “Madam, we’ve already established that. Now we are haggling about the price”

To belabor the obvious, McKinsey isn’t a charity, and it should be judged by its actions, not bizarre claims about its piety.

And for the praise of passion? Jihadists and other religious fundamentalists are also passionate. That doesn’t mean what they do is virtuous, merely that they have blind conviction.

______

1 I’m overdue for a post on McKinsey’s growing list of ethical lapses. I also have to differ with some of claims made in the Current Affairs piece. The author considerably exaggerates McKinsey’s historical clout; it’s almost as if, as a jilted lover, duped about McKinsey’s recruitment pitch about its special goodness, he now needs to see them as especially bad. And I don’t find it hard to believe that the firm often is pretty bad now. But even if McKinsey had been inclined to be many years ago, Corporate America wasn’t as rapacious as it is now, which served as a constraint on behavior, and McKinsey wasn’t as powerful or influential as the Current Affairs author suggests; it looks as if he needs to detox from this part of the firm’s Kool Aid.

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32 comments

  1. cnchal

    > . . . going from making offers only to the top 10% to over time, the top 30%.

    Where do the other 70% go if they can’t get into the fraud and greed business?

    Reply
        1. TMoney

          Telephone Sanitation Engineers Local 42 finds this comment insulting from a bloke with Wobbly Telomeres !

          Reply
  2. paul

    I know the word passionate is used a lot

    …and its use could only superseded as a more reliable signal to caution than a tattoo on the forehead.

    Reply
    1. chuck roast

      Thank you for that link. I listened to the Jaresko podcast. Natalie narrates on the theme that “we are all honest brokers here.” Of course, in her historical narration there is no mention of the endemic corruption in Ukraine; the multi-billion dollar Moldavian bank scandal or the fact that the necessary “debt restructuring” involved debt owed to Russia. Channeling Margret Thatcher TINA except a friendly restructuring by the IMF.

      The result of the IMF loan was of course austerity, but Natalie dislikes the term “austerity” and prefers the concept of “fiscal choices.” In Ukraine and PR we have very limited options as to where our expenditure should occur. Natalie says “I hope that I have never been the source of austerity in Ukraine or PR.” No irony here, simple cognitive dissonance. The woman is the archetypal, unapologetic neoliberal.

      She points out that the IMF loans to Ukraine had a whole set of pre-conditions associated with them. Similarly, the loans from the US had pre-conditions. When I heard her say this, I started laughing and thought, “Was one of the pre-conditions firing the Attorney General so he wouldn’t investigate Biden’s son for corruption?” Moving towards a market economy, she increased prices on natural gas 400%. For the poor and near poor this is the equivalent of saying, “Eat shit!”

      Anyway, the hairball that Jaresko describes as Puerto Rico will resist grooming until the curly locks of private equity and hedge funds are given a substantial trim. Time to sharpen Occam’s Razor.

      Reply
      1. Harry

        Since there has already been one haircut of bond holders, I would argue that it will be at least 3 years before the island will be in a position to ask for the next haircut of bond holders.

        Its not an iron law, or logically necessary. But it is my own personal experience, and lord alone knows I have bought a lot of defaulted bonds in my time. If anyone knows anyone at Cleary Gottlieb perhaps you can ask them.

        The PR haircut was way too small. Absurdly so. Which is why there will have to be an act II. But you know, no one will be able to admit the obvious for at least 3 years.

        Reply
  3. Colonel Smithers

    Thank you, Yves.

    Readers may note the name Natalie Jaresko. She served as Ukraine’s finance minister before returning to Foggy Bottom.

    Reply
  4. Larry

    So at this point McKinney just stands in for branding of the status quo. If preening Ivy Leaguers tell you to make bond holders whole, well who are you to disagree.

    What a disgrace. If only Trump had stuck to his moment of clarity on debt cancelation.

    Reply
  5. Judith

    This article is a useful lens to examine the behavior (not the words) of Pete Buttigieg, who worked at McKinsey. From Nathan Robinson’s detailed analysis:

    “All of this made me go back and rethink one of Buttigieg’s proudest stories. Every time the media talks about Buttigieg, if they mention anything other than his résumé, it’s his signature initiative to deal with “blight.” Buttigieg says that when he took office, there were “too many houses,” that the main complaint he received from residents was about the proliferation of vacant homes. His major policy goal, then, was to “repair or demolish” 1,000 homes in 1,000 days, a number his staff thought impossible. The council president called this an initiative to “right-size the city” (“right-size” is a euphemism from the business world used to make layoffs sound like the simple reasonableness of a corporate Goldilocks). Thanks to his diligent, McKinsey-esque management, Buttigieg blew past the goal.

    But news coverage of the plan makes it sound a little less savory:

    By leveling fees and fines, the city leaned on homeowners to make repairs or have their houses demolished. In many cases, Buttigieg said, the homeowners proved impossible to find amid a string of active and inactive investment companies. In other cases, he said, they were unwilling or unable to make repairs.

    Make repairs or have your house flattened? Wait, who were these people who were “unable” to make repairs? Were they, by chance, poor? Also, how did these houses become vacant in the first place? Were people evicted or foreclosed on? Look a little deeper into the coverage and you’ll find that this was not simply a matter of “efficient and responsive government,” but a plan to coerce those who possessed dilapidated houses into either spending money or having the houses cleared away for development:

    Community advocates in poorer, often African-American or Hispanic neighborhoods began to complain that the city was being too aggressive in fining property owners over code enforcement. The city leveled fines that added up to thousands of dollars, in certain cases, to pressure homeowners to make repairs or have their houses demolished.”

    https://www.currentaffairs.org/2019/03/all-about-pete

    Reply
    1. Raulb

      That article in currentaffairs is a wonderful piece of writing. The word ‘ethically inert’ comes to mind. There is something strange about these people that needs more analysis.

      The ieee recently did a piece on machine learning and bias and highlighted the curious case of St George Medical College in the UK where the vice dean rolled out an automated system in 1979 to make things more ‘efficient’ and ‘fairer’. Years later the complete lack of diversity was noticed but the vice dean resisted for years untill a formal complaint was made in 1986. Upon investigation it was discovered the program was docking 15 points for minorities and 3 points off women. It was designed by the vice dean.

      You see the same resistance in today’s machine learning community when serious problems around bias, racism and sexism is identified, there is a general inability to understand or relate to the serious consequences of their work with tonedeaf insistence on efficiency and the ‘fairness’ of data for ‘better outcomes’.

      Buttigieg and all these individuals have got used to a world somehow always acting in their interests and against others interests.

      Reply
  6. rd

    “greedy and out of touch”

    That is probably a feature, not a bug.

    If McKinsey really wants to be good and effective for society, they may want to do more recruting in the mid-level schools and GPAs looking for people who have a fairly broad eclectic range of interests and problem solving viewpoints. Unfortunately, the “Greed is good” era means that many of the top people coming out of these schools are just looking for the money. I think it is building its own Minsky moment where eventually the peasants will revolt and pull down the greed structure (or it simply collapses under its own weight, as it nearly did in 2008).

    Reply
  7. jfleni

    RE: McKinsey: Doing God’s Work in Puerto Rico.

    Forget it, God helps those who help themselves; forget about any connection with USA bloodsuckers,not USA
    statehood or anything similar. BE really INDEDPENDENT,
    not some god-forsaken colony. Join with other abandoned
    islands and colonies,D. Republic,Venezuala,Cuba, Cayman, etc. Let the Yanks piss up a rope!

    Reply
    1. Yves Smith Post author

      Ahem, are you kidding me? The US controls the seas. Puerto Rico has no army, no navy, and imports 85% of its food. It could be starved out in no time. Puerto Rico citizens are automatically citizens of the US, and there would be no local support for giving that up. It has an electrical system that’s been neglected for years.

      And despite being in a depression for the last 13 years and being further squeezed, Puerto Rico is still doing better than any independent Latin American country:

      In comparison to the different states of the United States, Puerto Rico is poorer than the poorest state of the United States, with 45% of its population living below the poverty line.[d] However, when compared to Latin America, Puerto Rico has the highest GDP per capita in the region, as well as being the most competitive economy among Ibero-American states, surpassing Chile and Spain.

      https://en.wikipedia.org/wiki/Economy_of_Puerto_Rico

      Reply
          1. Yves Smith Post author

            Sorry, per capita income DOES mean its citizens have higher incomes. And Puerto Rico, until the post-Maria hawking of PR as a plutocratic tax haven, had less income inequality than most Latin American countries, meaning less in the way of a super-wealthy cohort distorting averages.

            Reply
  8. Frank Little

    Thanks for this illuminating post, Yves.

    Over the weekend I read a story that may have been shared already on NC about an ongoing legal case against McKinsey alleging that they have been double dealing its clients when advising them in bankruptcy proceedings.

    From NYT: One Man vs. McKinsey: A Billionaire Says the Consultancy Has Rigged the Bankruptcy System:

    He believes the firm has improperly earned tens of millions by concealing its own investments in bankrupt companies and their creditors, then helping decide how much the failing company must pay them. Mr. Alix also accuses McKinsey of “trafficking in the assets” of bankrupt companies: quietly selling off the viable pieces to the other companies it represents.

    I was looking at Reuters while waiting for an email and came across this story from yesterday and thought of it in light of your post:

    From Reuters: Banks ordered to disclose bondholder information to Puerto Rico board

    U.S. Magistrate Judge Judith Gail Dein’s order said “good cause exists” to grant the board’s motion, which seeks to compel banks to submit bondholder names and addresses along with Puerto Rico debt payments the bondholders received between 2013 and 2017.

    The Bank of New York Mellon, Bank of America Corp, JP Morgan Chase Bank, and U.S. Bank objected to the board’s request last week, citing concerns over disclosing confidential customer information, as well as the cost and ability to produce a large amount of information by the April 19 deadline set by the board.

    The judge ordered the banks and the board to submit a proposed confidentiality agreement by April 23 and set rolling deadlines of April 25, April 30 and May 8 for the banks to submit bondholder information. She rejected requests by the banks to be reimbursed for their costs and for indemnity for claims that could result from compliance with the order.

    Hard for someone like me to really know what if any connection there might be between these two things, but it might help explain McKinsey’s insistence on austerity to pay back creditors over things that would, I don’t know, help people who actually live in Puerto Rico.

    Reply
  9. JimTan

    “The article misses that McKinsey almost certainly has an even greater commercial conflict of interest.”

    Yves- I think you’re right.

    McKinsey has an incentive to favor Puerto Rico’s creditors which is above and beyond the fact that bond creditors are one of their preferred target customers. A NY Times article last year reported some specific dollar amounts of McKinsey’s conflicts of interest which prompted senator Robert Menendez to sent them a letter which included:

    “According to a recent New York Times report, McKinsey has failed to disclose its conflicts of interest in Puerto Rico, taking advantage of the lack of disclosure rules in the Puerto Rico Oversight, Management, and Economic Stability Act. To date, McKinsey has billed Puerto Rican taxpayers $50 million, but has failed to disclose its investment in Whitebox Advisors, a hedge fund which holds $10 million in Puerto Rico debt backed by sales tax revenue. In addition, through a subsidy called MIO partners, McKinsey itself owns $20 million worth of bonds issued by Puerto Rico. MIO Partners manages approximately $25 billion for McKinsey’s employees and retirees, and runs three hedge funds, all of which reported owning Puerto Rico sales-tax bonds. Clearly, McKinsey has a undisputed pecuniary interest in the resolution of ‘s debt.”

    Reply
    1. Yves Smith Post author

      I mean something different by “commercial conflict of interest” than you think I mean.

      The “greater than $20 million” was a reference to the NY Times article and alluded to the idea that McKinsey also had economic participation through various hedge funds in addition to the $20 million it owns outright.

      McKinsey favoring one side over the other would make at the absolute tops a 25% difference in the haircut. Say $30 million of total exposure. That’s $7.5 million. McKinsey is earning that much in less than three months on this Puerto Rico assignment, where the firm takes great pains to claim it’s making less than it “ought” to.

      The point is that the juice for McKinsey is in being perceived to favor creditors (as in really screw broke borrowers) to get more gigs like this.

      Reply
  10. Lynne

    Nothing to do with McKinsey, but I must say I’ve always hated that old story about Churchill and I really wish we could retire it. Notice she never says yes, and recall the old story about how in diplomatic circles, maybe means no. Yet Churchill is impliedly lauded for exploiting his position to ridicule women

    Reply
  11. ChrisPacific

    Back when I was entering the workforce I recall interviewing with a small, boutique strategy company with no name recognition that appeared to do good work. I remember one of them saying to me that the way you knew when you had it right was when the conclusion looked completely obvious to everyone. That didn’t mean it was obvious from the start (it usually wasn’t) but that you had done a good enough job of analysis and discovery, and summarising and presenting your evidence, that the correct conclusion was very clear and evident.

    The ‘aggressive consulting’ thing sounds like the antithesis of that.

    Reply
  12. Bill Wald

    “The island has also been victimized by the Jones Act, which requires that only US-flagged ships can visit its port”

    Not exactly. Jones Act requires that only US flagged ships can visit 2 consecutive US ports. That’s why cruise ships from Seattle to Alaska always make a quick stop at Victoria, BC.

    Changing the subject to economics, When I was a kid (DOB 1940) and flying was very expensive, Middle class people on the east coast made Cuba the the favored resort destination. Puerto Rico should have replaced Cuba as a vacation paradise after Castro controlled Cuba. Capitalism, like political freedom must be earned by the people who are being exploited, not imported to them. Capitalists don’t intentionally shorten the food chain.

    Reply
    1. Yves Smith Post author

      Virtually all ships that go to Puerto Rico, particularly for trade, are from US ports, so your quibble is not relevant. The Jones Act was even more destructive to Puerto Rico after Maria in that only US flagged ships could deliver relief to Puerto Rico by sea, and there weren’t enough to do the job.

      One of many articles on this topic:

      By now, you’d think the case for repeal of the protectionist Jones Act, a century-old relic from the Woodrow Wilson administration, would be so strong that we could close our laptops and declare the battle over. But we can’t, and it’s unfortunate because millions of Americans, including Puerto Ricans following Hurricane Maria last year, are paying hugely inflated prices for gasoline and other consumer products, thanks to a powerful maritime lobby.

      In 1920, the year the League of Nations was established and American women gained the right to vote, Congress passed the Merchant Marine Act, also known as the Jones Act, ushering in a form of protectionism for America’s shipping industry and seafaring unions that remains on the books today. The Jones Act requires vessels carrying goods shipped in U.S. waters between U.S. ports to be U.S.-built, U.S.-registered, U.S.-owned and manned by crews, at least 75 percent of whom are U.S. citizens….

      Because of this absurd, antiquated protectionism, it’s now twice as expensive to ship critical goods – fuel, food and building supplies, among other things – from the U.S. mainland to Puerto Rico, as it is to ship from any other foreign port in the world. Just the major damage done to Puerto Rico from the Jones Act is enough reason to tell us that now is the time – past due time – to repeal the anti-consumer Jones Act.

      https://thehill.com/blogs/congress-blog/politics/409752-damage-done-to-puerto-rico-by-the-jones-act-illustrates-the-need

      Reply

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