Monday, July 13, 2015

The Puerto Rico Debt Crisis — Like Greece, Sort Of


"America" from West Side Story. According to YouTube, this appears to be from one of the more recent Broadway Broadway performances. (Full movie scene at the end of this piece.)

by Gaius Publius

Because of the coverage of Greece and its debt problems, I've been fielding a lot of questions about Puerto Rico and its debt problems as well. Puerto Rico's problems aren't the same as the Greeks' though; similar, but not matching. For one thing, Puerto Rico is a territory of the U.S. and subject to some unique-to-itself U.S. laws. Greece is under the thumb of northern Europeans.

Nevertheless, like Greece, Puerto Rico doesn't have its own currency and doesn't have "permission" to declare bankruptcy. There's a nice explainer at Vox — "Puerto Rico’s debt crisis, explained in 11 basic facts" — that's worth looking at. I'll provide the "11 basic facts" below with some explanation, and suggest that you click through to see any explanation you'd like to know more about.

Dara Lind, writing at Vox, begins with this:
Puerto Rico's debt crisis, explained in 11 basic facts

On June 28, the governor of Puerto Rico, Alejandro Garcia Padilla, announced that the island was not going to be able to pay the $72 billion it owes. The announcement is the culmination of several years of economic woes, but the island's debt has now become an urgent problem for the US territory — and therefore, for the US.

The problem is especially tricky because US bankruptcy laws don't allow government institutions in Puerto Rico to declare bankruptcy, as those in US states can. US policy did a lot to create the problem, and people on both sides of the debate — Puerto Ricans and the creditors who own their bonds — are Americans.

The worst news: The island's fate is in the hands of Congress.
Now the first of "11 basic facts":
1) Puerto Rico is sinking under $72 billion in debt

Puerto Rico has been dealing with a worsening debt crisis for several years. It's been suffering economically since 2006, but thanks to a federal tax loophole it's continued to be able to borrow money without people paying a whole lot of attention to its creditworthiness. As a result, both the main Puerto Rican government and its "public corporations" (like utilities) have racked up immense amounts of debt through bonds and tanked their credit ratings — even while trying to cut services and raise taxes. Now the Puerto Rican government is acknowledging that it's not going to be able to keep borrowing money just to pay off old debts.

So the question is whether Puerto Rico — either itself or its public corporations — will be able to declare bankruptcy and start working with a judge to restructure its debts. Congress is considering allowing some bankruptcy in Puerto Rico. But it's divided because many of the holders of Puerto Rican debt are American citizens and American investment funds.

2) Puerto Rico's economy has been struggling since 2006, when the federal government stopped offering business incentives

In the middle of the 20th century, the federal government wanted to encourage manufacturers that were tempted to move or expand to developing countries to move to Puerto Rico instead. But since Puerto Rico has the same labor standards as the US, that wasn't exactly appealing to businesses — especially when Congress decided in 1974 to bring Puerto Rico's minimum wage up to the rest of the US's, as well.
So instead, the government granted big tax breaks to businesses that had operations in Puerto Rico; starting in 1976, basically any profit a company could trace to Puerto Rico wouldn't be taxed. The tax breaks gave Puerto Rico a pharmaceutical industry.

This cost the US a lot of money in lost tax revenues, and in 1996 Congress decided to phase out the tax break. It officially ended in 2006, throwing Puerto Rico into a recession. (Many of the companies that benefited from the tax break moved to the Cayman Islands.)

That was swiftly followed by the Great Recession of the late 2000s, which basically kicked Puerto Rico while it was down. It's been struggling ever since. In 2013, 45.4 percent of Puerto Ricans were living in poverty.

3) People kept buying Puerto Rican bonds because of a quirk in the tax code

None of this sounds like a government you would want to invest in. And indeed, Puerto Rico's bond rating has been downgraded to junk level. But people continued buying Puerto Rican bonds even after it stopped being a good idea to do so.

The reason for this is, again, a federal tax break. Puerto Rican bonds are "triple-tax-exempt" — American companies and individuals who buy them don't have to pay federal, state, or local taxes on them. Typically, a municipal bond is only triple-tax-exempt if you buy it from the city where you live. But Puerto Rican's bonds are triple-tax-exempt for everyone. That made Puerto Rican bonds a particularly appealing investment opportunity — so appealing that people might not have looked too closely at the island's fiscal situation.

Right now, hedge funds hold about $15 billion in Puerto Rican debt, mutual bond funds hold another $11 billion or so, and individuals hold the rest. So the Puerto Rican debt crisis isn't just relevant to Americans because Puerto Rico is part of America — it's relevant because Americans are the ones owed the money.
And the rest:
4) Hundreds of thousands of Puerto Ricans moved to the mainland, worsening the economic crunch

5) Puerto Rico is caught in a "death spiral" of emigration, tax hikes, and benefits cuts

6) An obscure federal law from 1920 makes everything more expensive

7) It's not just the central government that owes money — it's also utilities and other public corporations

8) Puerto Rico can't declare bankruptcy. Neither can its cities or utilities.

US states can't declare bankruptcy. But "substate entities" within a state — like cities, judicial districts, or public corporations — can.

Puerto Rico also can't declare bankruptcy, but under US law neither can its "substate entities." If PREPA and other Puerto Rican public corporations were located in New York or California, they'd be able to declare bankruptcy — but because they're in Puerto Rico they can't. ...

9) Democrats are pushing to allow limited bankruptcy; Republicans say it isn't enough

10) Creditors argue that changing the bankruptcy laws is unfair

11) But if nothing changes, Puerto Rico is looking at a slow, rolling fiscal disaster

If Congress doesn't make any changes to bankruptcy laws, Puerto Rico is going to start falling behind on its minimum debt payments in mid-July. That opens up the possibility that individual creditors will start suing Puerto Rico to get their money back — and asking a judge to make the territory start paying any revenue it gets to its creditors, rather than paying its public employees or paying any benefits to its residents. ...
Two takeaways from me — One, we're living in a world where, according to those who run it, every creditor must be made whole, period, independent of the fact that risky bets (investments) come with risk premiums, which is by definition their compensation in case of default.

Because the investor class runs the (non-military, non–state security) aspect of the world, they can enforce a regime in which none of their friends can lose money, no matter how risky the bet (investment). Yet if Trump can declare bankruptcy (three times, or so I hear), the same should be allowed to Greece and Puerto Rico. In that sense, Puerto Rico very much resembles Greece.

The second is the "brown south" problem. In both cases, Puerto Rico and Greece, the debt is owed by "those people" to people who look rather white — most Americans, most Germans, most of the French and the Dutch.

I endured an interesting rant at dinner the other day. A perfectly nice (white) Frenchman started in on Greece and two phrases fell almost immediately from his lips: "I'm sick of having to continue to pay..." and "lazy." Mind you, not all French people think as my friend does. Thomas Piketty, who is French, is definitely not in that camp. Nor are all Germans and other northern Europeans.

But enough in the north are following the lead of German Finance Minister Wolfgang Schäuble, who seems to have taken the German reigns from Angela Merkel vis-à-vis Greece, that it sure looks like, down the road, the European project is in real trouble.

As is Puerto Rico. And as I said at the beginning, the fate of Puerto Rico is in the hands of Congress. Stay tuned.


Here's the whole scene plus song from the movie, featuring Oscar winners Rita Morena and George Chakiris. The intro dialog is quite good regarding the "brown south" issue. (I can't find a high-def version of this scene. If you locate one, please post a link in the comments and I'll swap it for this one. Thanks.)

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