For those who haven’t been paying attention, Puerto Rico is in serious financial trouble. It has accumulated more than $70 billion of debt, driven by reckless spending and short-sighted borrowing, that has left the commonwealth’s public corporations and utilities virtually insolvent. To make matters worse, the Puerto Rican government has engaged in a pattern of obfuscation, refusing to release audited financial statements and recently issuing dire new fiscal projections timed to come out just ahead of Treasury Secretary Jacob Lew’s recent visit to the island.
Most of the island’s debt was issued by the provincial government per se but rather by the various public corporations, municipalities and the island’s public power utility, but about 25 percent is debt issued by the government of Puerto Rico. Puerto Rico’s constitution explicitly guarantees debt issued by the commonwealth. Currently, each state can reorganize its non-general-obligation debt via Chapter 9 of the bankruptcy code, and some have suggested that the federal government merely extend Chapter 9 to Puerto Rico as well. Secretary Lew, along with Puerto Rico’s governor, Alejandro Garcia Padillo, want Congress to go one step further and give the island a “super chapter 9” that would allow it to reorganize and jettison some of its general obligation debt as well.
Absent that, Garcia Padillo has threatened to default on the island’s debt: It missed payment on a few bonds on January 1 so it is technically in default already, but hewing to this strategy will put the government in protracted litigation and shut out of the bond market for years, most likely forcing the federal government to intervene. Any sort of federal bailout will stick U.S. taxpayers with a bill they had no part in running up, a solution that sets a terrible precedent and one that no one on either side of the aisle seems particularly anxious to embrace.
Some analysts recommend that Congress appoint a fiscal control board that would be given the power to make tough tax and spending decisions while shielded from ordinary political pressures. Such an entity worked with a large degree of success in another entity without access to Chapter 9, the District of Columbia, and the District’s auditor recently hearkened for a return to the good old days when a fiscal control board oversaw the District’s budget.
While a control board might help might have positive effects on the Commonwealth’s future finances, it must not violate the Commonwealth’s Constitution by attaining the power to unilaterally restructure its constitutionally protected debt. The importance of Congress’s actions in Puerto Rico goes beyond the ramifications it will have on the island: no matter how strenuous politicians might assert that whatever action they take for the island is sui generis, the reality is that a Super Chapter 9 would serve as a precedent for dealing with the impending budget crises in various states. Illinois may be one bear market-cum-recession away from bankrupting its various pensions, and California’s debt situation isn’t appreciably better. States like Alaska and North Dakota, which get the bulk of their oil from natural resource extraction and have been constructing budgets based on three-digit oil prices for the foreseeable future, may find themselves unable to cope with their fiscal exigencies if they don’t find new revenue or dramatically cut back on spending.
While one main difference between the states and Puerto Rico in fiscal matters is that the states can avail themselves of Chapter 9 bankruptcy, the benefits of that privilege only goes so far: State governments themselves cannot reorganize under bankruptcy, since only their municipalities or independent government entities like public utilities can avail themselves of such protection and then only if the state government acquiesces to it. To be sure, Puerto Rico would benefit from that privilege but it’s no panacea: Doing such a thing without fixing its underlying economic morass would only delay the day of reckoning, and reorganizing without the explicit cooperation of its debtors would leave it unable to access bond markets going forward, an almost untenable situation.
A Chapter 9 that resembles the one currently available to the states would offer Puerto Rico significant relief, covering 74 percent of the island’s debt. Claims by the Obama Administration that traditional restructuring would only apply to about a third of the Commonwealth’s burden are unfounded; the only debt that is exempt is the $18 billion protected by the Puerto Rican Constitution.
Congressional procedure itself operates largely on precedent, so it’s not unreasonable to assume that whatever solution Congress works out for Puerto Rico will serve as the model for dealing with other state budget crises as they arrive. If bondholders pay most of the price for Puerto Rico’s profligacy then the states will see that approach as their opening salvo when it’s their turn to reorganize, and investors will act accordingly–by fleeing state debt the second that the Puerto Rican solution is finalized.
The hedge funds that own just 15 percent of Puerto Rico’s bonds (but receive a far greater share of the opprobrium for their investment) have signaled a willingness to work with the government to help reach an agreement that gives the island a path to renewed economic growth. Every entity with a stake in Puerto Rico’s fiscal future is going to have to make some sort of sacrifice if any reorganization is to succeed. Given the relatively small size of its constitutionally–guaranteed debt it ought not be impossible to craft a reform plan that would protect it but still provide a path to solvency.
The political pressure to do something, anything, in a crisis more often than not leads to bad legislation with scores of unintended consequences. It is the reason the founding fathers crafted a system of checks and balances that would be deliberately glacial in its operations. They recognized that reactionary legislating in response to popular opinion could only lead to disaster.
Those eager to get this Puerto Rico business done and over with to move on to other items on the Congressional agenda would do well to remember that this legislation could potentially play a large role in determining the country’s future process for dealing with insolvency in other cities, states, and territories. Setting a precedent of such import must be done with some foresight–which is not something Congress is all that good at.
Ike Brannon is president and Logan Albright director of fiscal studies at Capital Policy Analytics, a consulting firm in Washington, D.C.
