Puerto Rico, a U.S. territory acquired in the Spanish-American War, owes $73 billion and is set to run out of cash by September, according to a report issued Thursday by its Government Development Bank. That should be no surprise. The island’s government, which runs a rickety welfare state with excessive spending, has been borrowing like crazy.
Debt has ballooned so much that tiny Puerto Rico, with a population of just 3.7 million, would — if it were a state — rank third behind California and New York as America’s largest borrower.
The U.S. Treasury recently rejected pleas to guarantee or buy the island’s bonds. But now some in Congress, including House Judiciary Committee Chairman Bob Goodlatte, R-Va., are pushing special status for Puerto Rico in U.S. bankruptcy courts.
That’s a terrible mistake — not to mention a jarring rejection of principle for Republicans. Bankruptcy may look tempting as a way to zap public employee unions. But it’s a trap, with serious consequences.
In U.S. law, Chapter 9 is reserved for a municipality, defined by the law as a “political subdivision or public agency or instrumentality of a State.” That description does not, of course, fit Puerto Rico.
Also, it’s doubtful Chapter 9 is the answer for any government. The city council of Harrisburg, Pa., composed entirely of Democrats, tried to file Chapter 9 on its own in 2011. But Republican Gov. Tom Corbett intervened and appointed a receiver, who by 2013, according to the New York Times, “found a way to restructure crushing debts without a costly and contentious trip to bankruptcy court.”
In addition, changing the law to allow Puerto Rico to file Chapter 9 would certainly open the floodgates for irresponsible U.S. states to demand equal treatment. First in line would be Illinois, whose crushing debt burden is the legacy of 12 years of Democratic mismanagement.
Some conservatives are drawn to Chapter 9 as a way to force cuts in union members’ pension benefits. But the courts frequently reject those cuts. Stockton, Calif., for instance, emerged from bankruptcy in 2014 with a sales tax increase, haircuts for creditors, but no pension reductions.
Chapter 9 is an utterly unpredictable process that can drag out for years. Vallejo, Calif., spent 42 months in bankruptcy court, and San Bernardino entered bankruptcy in 2012 and still hasn’t exited.
Anyway, Puerto Rico doesn’t need bankruptcy. With default imminent, Prepa, the government-run power company with $9 billion worth of its own debt, has been negotiating with lenders and making good progress. But why would Puerto Rican officials want to continue such talks if the U.S. Congress gives them the escape valve of Chapter 9? And why would they ultimately want to tackle the real answer to their problems — their own poor stewardship?
Puerto Rico has heavy taxes on industry and chronic overspending by government, with 28 percent of its workforce in the public sector. And 40 percent of its sales and use taxes go uncollected.
Striking a responsible agreement with creditors would send a positive signal to businesses that now are avoiding the island because of the economic and political chaos there. Productive residents are also fleeing. From 2000 to 2013, about 400,000 more people left the island for the mainland U.S. than the other way around. Since 2006, economic activity has dropped 20 percent. The labor force participation rate is a minuscule 41 percent, compared to 63 percent in the United States and 62 percent in Mexico.
Those are the problems Puerto Rico should be tackling. And if Puerto Rico’s government can’t do the job, then the solution is a control board, like the one that Congress imposed on Washington, D.C., in 1995 after Congress wisely rejected the Chapter 9 route. Before disbanding in 2001, the board forced the city to put its finances on an even keel.
Finally, if Chapter 9 is applied to Puerto Rico, it will be unfair to investors who bought bonds before any change in bankruptcy rules was contemplated. The president of Puerto Rico, Alejandra Garcia Padilla, made just this point recently when he urged protection for “Puerto Ricans who have put their savings in our bonds.”
The same protection, of course, should apply to American investors as well. For example, Oppenheimer Rochester Maryland municipal bond fund holds seven separate Puerto Rico bond series among its top 25 holdings, including its number-one asset.
Chapter 9 would be a disaster, both for Puerto Ricans and for Americans. The island needs a free-market, negotiated solution — or, failing that, a control board. Otherwise, I’m afraid those of us on the mainland will be on the hook.
James K. Glassman, former U.S. Under Secretary of State for Public Diplomacy and Public Affairs, is a Visiting Fellow at the American Enterprise Institute. Thinking of submitting an op-ed to the Washington Examiner? Be sure to read our guidelines on submissions.
