Puerto Rico Officially Defaults

August 4th, 2015 by

puerto_rico_flagIn what is being labeled by Business Insider as the “biggest municipal default in history,” the saga of Puerto Rico’s crippling debt has taken a definitive turn. The island government paid just a fraction of its $58 billion tab on its maturing securities, officially defaulting on its debt obligations. The non-payment event was triggered by an impasse in local legislators agreeing upon a budget, as the Caribbean island no longer has enough funds from its general-obligation bonds to cover its own expenses and pay off creditors on time. These general-obligation bonds, the main source of the Puerto Rican government’s funding, now total $72 billion owed, a sum that Governor Alejandro García Padilla insisted last month that his country simply could not pay.

Fiscal Limbo

As a U.S. territory, but not an independent state, Puerto Rico is in an awkward bind. Under the law, it can’t file for Ch. 9 bankruptcy like full-member U.S. states; at the same time, the island has no recourse to seek relief from the IMF or other international or supranational organizations because it lacks sovereign status. Congress is currently floating ideas for amending the law to allow Puerto Rico some avenue for dealing with the hole their government has dug.

defaultPuerto Rico is now seeking a writedown of its outstanding debts, as most analysts conclude that a haircut in the range of 35% to 50% will be necessary to make the country’s debt load manageable again. During the boom years of the previous decade, Puerto Rico borrowed and spent heavily, not unlike the similarly debt-burdened Greek government.

Causes and Effects of the Debt Burden

Puerto Rico now faces an extreme problem of liquidity, though the ominous signs have been mounting for at least the past two years. The country’s bonds are tumbling, trading at less than 69 cents to the dollar and continuing to fall. Preliminarily, the government says it will announce a restructuring plan for its debt and its broader economy in September.

Old_San_Juan_aerial_viewCreditors are insisting that the island merely need cut back its spending and implement austerity measures in order to get back on track and regain solvency. (Creditors demanding austerity: sound familiar? Even German Finance Minister Schaüble joked about trading Puerto Rico for Greece.) Although this sounds simple enough, others are suggesting that some form of devaluation is necessary in order for the Puerto Rican economy to again become competitive. At the moment, wages are fairly robust in the country, but productivity lags behind.

Moreover, the making whole of creditors’ investments is almost certain to take a backseat to the government meeting the needs of the Puerto Rican citizens. Public services and normal operations must be serviced if the economy is to rebound in any meaningful way, but the tension remains between paying creditors and keeping the island running. Much of Puerto Rico’s massive debt is held by large hedge funds who are unlikely to accept any sort of reduction of the debt levels owed, similar to the developments that have plagued Argentina.

What’s Next for Puerto Rico?

The problem of Puerto Rico’s competitiveness and productivity (or, more accurately, lack thereof) will undoubtedly weigh on any decisions about how to restructure the economy. There are plenty of bad signs that abound: despite a progressive increase in spending on education, the island has seen school enrollment drop by 1/4 from its highs, and more than a hundred schools have been closed. If this squandering of funds wasn’t enough, the island has a serious migration problem: Puerto Ricans have been moving to the U.S. in large numbers as the prospects for the economy have soured, with a 12% drop in population over the last decade.

Whatever the outcome of Puerto Rico’s default (an outcome that won’t come for many months, if not longer), the U.S. government would be wise to reconsider its laws and regulations governing the official status of Puerto Rico, if only to avoid messy scenarios like the one now at hand in the future.