PUERTO RICO’S DEBT CRISIS
On June 28, 2015 the Governor of Puerto Rico, Alejandro García Padilla, announced that the $72 billion debt owed by the Commonwealth to its creditors was unpayable. This pronouncement made official a looming debt crisis that had been building since 1973. At that time Puerto Rico began to spend more than the revenues it collected. Recognizing it was overextended on a creditor debt it had accrued over years, the government began to issue more bonds to sustain its daily operations and keep the economy stable. This incurred even more creditor debt. The public debt inevitably grew, from $3 billion in 1973 to 9 billion in 1986 to 35.7 billion in 2005 to $72 billion in 2015. In addition to the public debt, an additional $49 billion is owed to unfunded pension obligations. Thus, the Commonwealth of Puerto Rico owes
a total of $123 billion.
Puerto Rico, as an unincorporated territory, cannot file for Chapter 9 bankruptcy although this is allowed in municipalities in the fifty states. Hence the Governor’s declaration.
On June 30, 2016, President Barack Obama, with the blessing of the Supreme Court and Congress, signed into law the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) leading to a Congressionally takeover of the island’s financial management and mandating austerity measures that have inflicted hardship on the island’s economy and its people to the present. When a major hurricane, María, devastated the island on September 20, 2017, the Puerto Rican economy was further struck with adversity.
PUERTO RICO: A COMMONWEALTH
When Spanish explorers encountered Puerto Rico in 1493, the island was populated by the Taino Indians. The explorers claimed the island and its people for the Spanish crown. Puerto Rico remained under Spanish rule for four hundred years until 1898 when the United States went to war with Spain. After the defeat of Spain by the United States, Puerto Rico came under United State military governance. The Foraker Act of 1900, passed by the United States Congress, established civilian rule of Puerto Rico with a Governor and Executive Council appointed by the President of the United States and created a House of Representatives and Judicial system patterned after the United States Constitution. Since then, Congress has enacted the following laws.
In 1917, the Jones Act granted U.S. citizenship to all Puerto Ricans.
On July 3, 1950, the Congress of the United States passed Public Law 81-600, 64 Stat.319, which authorized Puerto Rico to draft it’s own Constitution. The Constitutional Assembly met from 1951 to 1952 and drafted the Constitution which was presented to the people of Puerto Rico in a national referendum on March 3, 1952. The Constitution was approved with an 82% majority of the Puerto Rican people and later ratified by the U.S. Congress with a few amendments.
The Constitution of the Commonwealth of Puerto Rico is composed of nine articles detailing the structure of the government as well as the function of several of its institutions. It also contains a Bill of Rights patterned after the United States Bill of Rights. It established the island as a Commonwealth under the sovereignty of the United States with an elected representative to the U.S. Congress who can attend but not vote. Although Puerto Ricans have been drafted into the United States army in time of war, Puerto Rican citizens cannot vote for the President of the United States.
In many ways the present debt crisis in Puerto Rico is an outgrowth of its Commonwealth status. Puerto Rico’s ability to govern and monitor its economy is dependent on decisions made in Washington. For example, the Jones Act includes naval laws that require all goods ferried to and from Puerto Rico to the mainland be carried on ships built, owned and operated by United States citizens. Puerto Ricans must pay much higher for imported goods such autos, television and other product than they might if they received their goods from other sources.
Puerto Rico’s economy has traditionally been shaped and dominated by mainland investors and entrepreneurs. The economy under early US rule was dominated by sugar industry magnates who made sugar the dominant export instead of allowing for the development of a diversified homegrown island economy. In subsequent years, the island’s economy has continued to be dependent on investments from the mainland for industrialization, including the petroleum industry and more recently pharmaceuticals.
Another way in which Puerto Rico’s commonwealth status has helped shape the crisis has been the prevision in the Jones Act which exempts interest payments from bonds issued by the Puerto Rican government and its subsidiaries from federal, state and local income taxes. This so-called “triple exemption” for tax free investment, regardless of where the bondholder lives, has led investors from the mainland, notably municipal investors, to seize on this as an investment opportunity. Not surprisingly, this factor led the Puerto Rican government and subsidiary governmental agencies, to issue bonds to balance the island budget. This began in earnest in 1973 and continued throughout the next four decades.
Bonds issued by the Commonwealth of Puerto Rico have been increasingly degraded since the 1970s. In 2006, the Commonwealth created the Puerto Rican Sales Tax Financing Corporation (COFINA), the corporate arm that currently backs the bonds that resulted in the $72 billion dollar debt.
The financial devaluation came to a head in 2014, when the Puerto Rican debt rose to $71 billion. At that time three major bond credit rating agencies, Standard and Poor, Moody and Fitch, downgraded the bonds as “junk bonds,” not worthy of investment. When the Puerto Rican government began repaying debt due with new debt bonds, often refinancing low interest rates with higher interest rates, the inevitable unsustainability of this approach soon became evident, Congress eliminated the tax credits entirely in 2016.
This triggered a panic among investors that Puerto Rico would default on its debt. Such a default would not only jeopardize creditor investments but would also limit Puerto Rico’s ability to issue any future bonds, making it virtually impossible for Puerto Rico to meet its day to day financial needs or ever get itself out of debt. This led to Governor Garcia Padilla’s announcement that the Puerto Rican debt was unpayable.
With the creation of the Puerto Rico Oversight, Management and Economic Stability Act (more commonly known by the ironic anagram of PROMESA, Spanish for “Promise”) President Obama appointed a seven-member Oversight Board that had ultimate control over the Puerto Rican budget and was entrusted with negotiating a restructuring of the Puerto Rican debt with its creditors. The Oversight Board, known in Puerto Rico as La Junta de Supervision Fiscal (JSF) or more commonly, La Junta, has far reaching powers. It must oversee and monitor the island’s budget and may institute hiring freezes, prohibit the Commonwealth from entering into contracts or sell off any of its assets.
One of the criticism of the Oversight Board is that it has effectively taken over the role of elected officials in Puerto Rico. For example, the Governor may structure austerity and other measures, and offer a structuring plan, but must ultimately defer to the superior authority of the Oversight Board for approval. The financial autonomy that was granted by the 1952 Commonwealth Constitution has been overruled and an elected government displaced by an imperial board of proconsuls with overriding powers of control.
In 2006, the Commonwealth created the Puerto Rican Sales Tax Financing Corporation (COFINA), the corporate arm that currently backs the bonds that resulted in the $72 billion dollar debt.
Governor Ricardo Rosselló was elected to succeed Alejandro García Padilla on November 8, 2016,. Since 2016 Rosselló has worked with the Oversight Board to reach a restructuring deal with its creditors. But while the Board emphasizes repayment of the debt as a paramount concern, many respected economists fear that an approach that does not take into account the need to for incentives to enhance the island’s economic growth, are shortsighted and may create more economic and social chaos. Indeed, the government’s efforts to increase revenues and reduce its expenses by increasing taxes while curtailing public services and reducing worker’s benefits has resulted in island-wide protests.
In March 2017, Governor Rosselló, with the approval of the Oversight Board, offered Commonwealth creditors a plan that would repay a quarter of the debt. Creditors responded by filing lawsuits demanding full payment of the debt. Although Puerto Rico cannot file for bankruptcy under Chapter 9, the provisions of PROMESA do allow for a process similar to bankruptcy. In response to the creditors demand for full payment, Governor Rosselló asked the Oversight Board for relief under these provisions of PROMESA.
To resolve the competing litigations, Supreme Court Justice John Roberts, on May 5, 2017, assigned Judge Laura Taylor Swain of the U.S. District Court for the Southern District of New York to oversee the cases. Judge Swain allowed the Oversight Board and the Commonwealth to pursue separate lawsuits. But on February 5, 2019, the Judge ruled that the restructuring plan put forth by Rosselló could go forward.
The agreement allows for the payment of $17 billion, almost a quarter of the $72 billion debt, to be paid to creditors. “Senior” creditors will recoup approximately 93 percent of each dollar but “junior” investors with less capital invested will get about 55 percent. The payment is guaranteed by Puerto Rico’s Sales and Use Tax (SUT), known in Spanish as Impuesta a la Venta y Uso (IVU).
After 40 years of the restructuring plan approved by the Oversight Board, creditors will have recouped $32 billion in principal and interest, back by the Sales and Use Tax which is estimated to make 75 billion dollars during this same time period.
Additionally, the Oversight Board estimates the restructuring will save an average of $456 million a year in debt service which the government can then use for health care, education and other services. Nonetheless, the stringent austerity measures already demanded by the Oversight Board will remain in effect.
The restructuring deal has met with opposition from both creditors and large segments of the Puerto Rican community. Some of the bond holders are rumored to be considering an appeal of the restructuring plan. Meanwhile, many Puerto Rican civic and oversight groups such as the Center for Popular Democracy (CPD), the Citizen Front for the Debt Audit (Comisión Ciudadana Para la Auditoría Integral del Crédito Público), and Puerto Rico’s Citizens for Debt Audit (Frente Ciudadano por la Auditoría de la Deuda) all denounce the approval of the restructuring plan as an easy way to appease bondholders while ignoring the long term development needs of the Puerto Rican economy.
This thesis is echoed by prominent economists Joseph E. Stiglitz and Martin Guzman who assert that the government’s action will inevitably cause a “social and economic catastrophe.”
Written and copyrighted by by Jesús Salvador Treviño and José M. Umpierre. Governor Padilla image, Cofina and Promesa logos used under the fair use proviso of the copyright law. All pother image sin the public domain.