“Puerto Rico: Bankruptcy, Bailout or Bust”
Ty J. Young Editorial
Puerto Rico’s budgetary woes have been airing on TV commercials. Since 2008, the stress on municipalities, cities and states throughout the country have been evident; many teeter on the edge of bankruptcy. Of course, we all know that is the path Detroit has taken. Under U.S. law, municipalities file bankruptcy under Chapter 9 – a specific code that deals with government entities like cities and counties.
However, Puerto Rico is not a state nor a city, and therefore does not enjoy the protection of U.S. bankruptcy law.
Municipal bankruptcy is rare but does happen. U.S. territories going belly up would not be unprecedented, but the size and scope of the Puerto Rican collapse has been alarming. The commercials are causing fear with retirees who hold Puerto Rico bonds. Below are some of the history and facts regarding this very real financial crisis:
I. Past U.S. Municipal Defaults and Bankruptcies
1. New York City Default. Although Congress provided bankruptcy legislation which was essentially bailout legislation, President Ford vowed to veto any bankruptcy including bailout funds. The famous line attributed to him was largely untrue, but had the same effect: “New York, drop dead!” Mayor Beame had already drafted seizure notices to the banks, city lights were to be turned off, and bills would go unpaid. The public was aware of the problems the city was having, but no one knew how close they were to anarchy. Thankfully, unions and political leaders agreed on haircuts to debt and using union funds for loans to the city. While it was a technical default on the debt, there was a restructuring and the city survived – without a government bailout.
3. Detroit, MI. The largest city bankruptcy in U.S. history occurred in Detroit, MI. Decades of one party rule had created the quintessential example of waste, graft, and corruption. Exorbitant salaries and pensions for politicians and government officials, combined with pension promises which could not be kept, drove the city into financial ruin. Ignoring the federal government’s instruction through a “Super Chapter 9” bankruptcy bill, Michigan has reformed its budget process, invited investment, and renegotiated with creditors. The state could be on its way back to fiscal health.
II. How did Puerto Rico get in this position?
1. Bad government. The unincorporated U.S. territory pays high government salaries and pensions exceeding the average salaries the pensioner received while working. Plus, over 20% of the population works for the government. That is not sustainable anywhere.
2. Tax base is shrinking. 33% of the island’s population receives food stamps, and most able-bodied Puerto Ricans leave the island to work in the U.S. Despite the obvious potential as a tourism destination – which it is – Puerto Rico is losing what little labor force it has to the mainland.
3. Reckless government spending and mismanagement. Sound familiar??? The only problem is Puerto Rico cannot print its own money (which, as we know, creates even more problems – but that is a story for another day). All energy usage is derived from government controlled agencies. Most of the tax collection process is corrupted. Nothing about Puerto Rican leadership shows fiscal restraint or budgetary balance … why would we expect that change?
III. What are Puerto Rico’s options?
1. Super Chapter 9 Bankruptcy. This has been proposed by the Obama Administration and even supported by some Republicans. If this legislation is passed, it would allow Puerto Rico to enjoy the same bankruptcy protections as states. However, unlike current Ch. 9 Bankruptcy law, this “Super Chapter 9” Obama proposal would include widespread public sector bailouts for unions and government employees, while forcing individual investors who purchased Puerto Rico bonds they thought were safe to forfeit their entire life savings, in many cases. How is that fair? This is “Dead-on-Arrival” for most conservatives.
2. Traditional Ch. 9 Bankruptcy. Unlike Super Chapter 9, EVERYONE takes a haircut. Puerto Rico has stated it wants Super Chapter 9 (obviously). In either case, bankruptcy will not solve all of its problems. The need for fiscal and monetary reform are needed soon if Puerto Rico is ever going to turn the tide of debt, deficits, and bankruptcy.
3. Negotiate with creditors, implement fiscal reform. PREPA, the Puerto Rican Electric Power Authority (i.e. – government monopoly) had already renegotiated a deal with bond holders and were expecting another $2 billion line of credit, but the battle in Congress over the Super Ch. 9 legislation killed the deal. Puerto Rico already defaulted on most of its debt payments back in 2015, and has $72 billion in debt. The average U.S. state debt to personal income ratio is 3.4%. In Puerto Rico it is a staggering 89%. Get the Fed’s out of the way and Puerto Rico will be forced to reform. The territory will receive better deals, and everyone will share in the problem solving.
No doubt, bondholders and creditors are at risk of a significant loss, so the lady on the TV commercial has cause for concern. Many have already taken a hit to their 401k’s as the value of those Puerto Rican bonds have declined. Another bailout or Ch. 9 legislation, which only protects Puerto Rican government employees, will be a disastrous precedent, and a perfect storm of moral hazard. Bondholders are at risk, but do not put U.S. taxpayers on the hook as well. Any deal resulting in bailouts or bankruptcy could wipe out the redemption value of those bonds altogether.
You are not on the hook now, but the President and Congress are in the process of putting you on the hook – which equals greater, future taxation. There is no other logical conclusion … do not let them do it!
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