May 19, 2016 UPDATE: Leadership of the House Natural Resources Committee introduced HR5278 on May 18, compromise legislation which would address the Puerto Rico Debt Crisis. While the legislation is not perfect, it would address the debt crisis in an organized manner without a taxpayer bailout. The American Security Project supports this legislation and calls for both the House and Senate to promptly consider and pass this legislation.
Puerto Rico, its bondholders, and the country have passed an ominous deadline. The island commonwealth, a territory of the United States, has defaulted on a $400 million payment due on May 1. This is not some isolated crisis far from American shores. Puerto Rico is home to approximately 3.5 million people – all American citizens. The ongoing economic calamity on the island has triggered one of the largest non-conflict migrations in recent memory. A default could have systemic effects throughout the American financial system, as Puerto Rican debt was widely seen as a safe, long term investment. And, with more payments looming on the horizon, this situation needs to be resolved immediately.
Since the beginning of 2016, the Commonwealth has begun defaulting on its debt of over $72 billion. Health, education, and public safety services have been curtailed because the government cannot pay all of its bills. The result is that hospitals are closing floors, businesses are being pushed to insolvency, and thousands of working-age Puerto Ricans are leaving the island for better job prospects on the mainland. The failure of essential government services on the island is occurring as Puerto Rico has become ground zero for the Zika virus, which the CDC estimates may affect 25% of island residents.
A Looming Security Crisis
This is not just an economic calamity. The Caribbean is America’s third border – islands like Puerto Rico are high traffic trans-shipment points for drugs and human trafficking, which have entered through South Florida. Efforts in recent years by the military, Coast Guard, and police forces have staunched that flow. However, a collapse in Puerto Rico could undo the good work, as the island enjoys passport-free access to the Continental United States. As the southernmost part of the U.S., if the fiscal catastrophe in Puerto Rico is not halted, it could be a substantial concern for U.S. national security.
The Roots of the Problem
The debt crisis in Puerto Rico is a symptom of almost a decade of economic decline on the island. A series of economic shocks, from a housing bubble to a credit-crunch, withdrawal of manufacturing, oil price spikes, and high labor costs have all rocked the economy. Energy costs are between two and three times more expensive than on the mainland. The result is that the Real GNP in Puerto Rico is lower today than it was in 2000. With such a collapse in economic growth, a debt crisis was nearly inevitable.
But no one should blame outside factors alone. Puerto Rico’s government has long spent beyond its means, and a vein of populism that runs through the governing political parties has willfully handed out government funds to connected groups. The result is that more than 25% of the jobs in the Commonwealth are in the government – significantly higher percentage than any state.
By law, Puerto Rico cannot declare bankruptcy (neither can any U.S. State for that matter). However, mainland municipalities and their state-owned enterprises or utilities can, while municipalities and utilities in Puerto Rico cannot. Even though the government of Puerto Rico has attempted to negotiate a reduction in the debt burden and has gone to great measures on its austerity programs, no agreement has been reached, and defaults have begun.
The Medicine Needed
The acute and immediate challenge is to find a solution to the debt crisis. There is simply no way for Puerto Rico to pay the $70 billion debt it now owes. On the other hand, the debt is so large that if Puerto Rico simply stops paying its bills, it could undermine the entire U.S. municipal bond market – a cornerstone of economic growth and development around the country.
Only action by the U.S. Congress can solve this situation
There appears to be emerging bipartisan agreement in Congress for legislation that would combine a fiscal oversight board that could mandate fiscal discipline with authorization to allow for a process like Chapter 9 bankruptcy. Although an unelected fiscal oversight board is likely to be unpopular in Puerto Rico, this model has worked in the past in cases like New York City’s 1975 budget crisis, or Detroit’s recent collapse. And a court-run bankruptcy process is not a perfect solution, but it would allow for an equitable and orderly extension and trimming of debt.
Both the House and Senate have legislation that they are considering, but have not yet enacted. No bailout of Puerto Rico is needed, and this compromise solution would not cost American taxpayers a penny. Intervention would stave off a substantial man-made humanitarian crisis affecting 3.5 million Americans, which has triggered a wave of internally displaced people across the U.S.
The Way Forward
However, debt relief and fiscal discipline would only serve to give Puerto Rico time – it would not solve the problem. Puerto Rico needs above all to return to economic growth. In fact, heavy fiscal tightening – as a fiscal oversight board would enforce – will serve to actually make the economy worse in the short term. The only way to return to economic growth is for Puerto Rico’s businesses and workers to become more competitive; they must become more productive, more efficient, and a more attractive place to invest.
Recent examples of Greece, Portugal, and Ireland in the EU show how challenging it is for small economies that are tethered to a large currency union to regain economic competitiveness. That is why it is so important that Puerto Rico do everything it can to encourage work and private investment, while also upgrading infrastructure.
One thing that could promote long-term growth while also raising the revenue needed to pay off debt is to privatize the large swaths of the government that do not need to be government-owned. No American state, for instance, has a centralized state-owned electricity utility (though there are some municipal and cooperatively-owned utilities). PREPA, the island’s electric utility, is the largest single holder of debt and has underinvested in transmission infrastructure, has blocked energy innovations that could reduce costs, and is rife with corruption. Efforts to privatize or reform PREPA could raise revenue for the state, while also increasing efficiency at PREPA and reducing the onerous electricity rates on the island.
Congress Must Treat Puerto Rico with Respect
While the question of whether Puerto Rico is to become the 51st State is rightfully not a part of this conversation, both Puerto Rico and the U.S. Congress should begin holding the Commonwealth to the standard of other states. That means that Puerto Rico should not seek, nor acquire any preferential treatment – like new federal tax exemptions or any exemptions from the federal minimum wage. But it also means that Congress should stop punishing Puerto Rico, like how the Jones Act drives up Maritime shipping costs, which are passed along to consumers and businesses alike.
It is Passed Time to Act
The situation facing Puerto Rico is now a crisis. Congress can no longer defer the hard decisions: it is time to restructure the island’s debt and put the Commonwealth back on the path toward economic growth. If West Virginia, Alaska, or Massachusetts were in such a state, would Congress have waited this long to act? No bailout of Puerto Rico is needed, but the longer Congress delays, the greater the self-inflicted damage to the island, the municipal bond market and confidence in the U.S. economy. Failure to act now, while the crisis can still be reversed in a cost-controlled manner, will only make any intervention more complex and costly.