Puerto Rico is in a financial bind. The Commonwealth, along with its public utilities and various municipalities, collectively owes more than it can realistically repay.
The island’s government would like the option to do something similar to what Michigan did to help Detroit: give its municipal corporations the ability to restructure their debts under Chapter 9 of the federal bankruptcy code, bring its creditors into a negotiation, and craft a viable reorganization plan that gives the island’s economy some breathing room and politicians some authority to undertake further economic reforms.
The only problem is that Puerto Rico—unlike the 50 states—cannot use Chapter 9, for historical reasons that no one remembers and that don’t make good financial sense. The island tried to get around that obstacle by passing legislation that would have accomplished nearly the same thing as a Chapter 9 restructuring, but a federal judge in Puerto Rico struck down the new law. Puerto Rico also has asked Congress to amend the bankruptcy code to treat it like the 50 states, and the House Judiciary Committee recently held a hearing on the issue.
This effort has fomented opposition among some Tea Party groups, who argue that such an action would be tantamount to a federal government bailout of the island’s economy. This opposition apparently worries some Republican congressmen, who fear any accusations of profligacy.
However, the notion that it would cost the federal government money if Puerto Rico’s municipal corporations were permitted to restructure their debts under Chapter 9 woefully misconstrues both Puerto Rico’s current situation as well as how a Chapter 9 proceeding actually works. Absent some sort of restructuring under Chapter 9, Puerto Rico’s situation may keep deteriorating until a federal role—along with a potential federal bailout—becomes necessary.
There is no disputing that Puerto Rico faces financial problems. The island has been in a recession for nearly a decade and has run annual deficits that entire time, leaving it with an accumulated debt of $73 billion, or about 70 percent of annual output.
At this point, it is pretty much out of options: It has privatized its airports and many of its roads, and has gone about as far as it can, politically speaking, in reducing government employment and boosting taxes. Such measures have not proven to be enough.
Its creditors have come to appreciate the bind and have acted accordingly: It has become much more expensive for the Commonwealth to borrow money, and its outstanding debt trades at a steep discount. Any mom and pop investors who bought Puerto Rican debt in order to possess a safe, predictable, and tax-favored investment have long since sold off, and these days most of the island’s debt is held by hedge funds that fully understand the risks inherent in investing in the island.
The creditors who remain would like to see some sort of resolution that puts Puerto Rico on a path to a sustainable economy, and most of them would take a haircut on their debt if it gave them some hope that growth on the island would resume.
What would happen if the island were allowed to exercise the options inherent in a Chapter 9 restructuring? The municipalities and public utilities in the worst shape (most notably PREPA, the debt-burdened public utility) would file under Chapter 9 and there would be a restructuring process akin to Detroit’s.
Everyone—from the bondholders to the pensioners to the taxpayers to PREPA’s ratepayers and customers—would end up taking a hit, and they would all acquiesce if the pain were shared and the resulting reforms gave hope of a significant improvement in the island’s economy and fiscal health.
Without any legal suasion to force its various creditors to come together, the island could limp along a while until its credit markets simply seize up and there is no way to refinance its debt.
When that happens, the federal government’s hands will be tied—it will need to act, and in a way that will probably cost it some money, either by financing the Commonwealth’s loans or by providing more tax breaks to further incentivize businesses to locate there. A Chapter 9 restructuring would preclude precisely such a necessity.
Many on the right have a reflexive opposition to bankruptcy. That is unfortunate, because it is a tool that is ultimately beneficial for economic growth. Once an entity—whether an individual, a business, or a government—reaches a point where it cannot pay its debts, everyone is better off if the creditors and debtors come up with a plan that compensates the creditors as fairly as possible, while allowing the debtor to emerge without an unmanageable debt constricting its options.
Denying Puerto Rico the option of Chapter 9 under the guise of fiscal conservatism simply makes no sense. There is no reason to think that an orderly restructuring would cost the federal government any money: The reality is that the longer we allow the island’s debt situation to metastasize, the more likely it is that the feds will end up on the hook.
Ike Brannon is a former economist with the United States Treasury.
