Puerto Rico Misses Bond Payment

The Commonwealth of Puerto Rico, not a state in the US union, missed a bond payment yesterday. This has been on the cards for a long time. Puerto Rico is in a legal netherworld. Unlike US municipalities, its public institutions have no access to bankruptcy court. Because it is not an independent nation, the IMF can’t help it. The American Congress holds the key to a solution, but politics are holding up legislation that could resolve this.

The Wall Street Journal reports, “On Monday, Puerto Rico was supposed to make a $422 million debt payment. The government paid $22 million in interest, a spokeswoman for the development bank said, but it missed a $367 million principal payment. The government earlier swapped $33 million worth of debt coming due Monday for new debt with later maturities, the spokeswoman said.” A further $2 billion in debt repayment is due this summer.

Puerto Rico has seen its population fall 9.1% since 2005 as people leave the island looking for opportunities elsewhere. Since they are American citizens, they have no problem coming to the mainland. Declining population creates a vicious cycle in which government revenues decline, which means there is less economic activity, which in turn motivates those who can to leave. Muddling through is impossible (Greece is the best proof of this), and a complete restructuring of Puerto Rico’s debt is needed.

Puerto Rico’s past governments (Governor Alejandro Garcia Padilla just got into office, inheriting the mess) borrowed heavily, and at 8% interest on the bonds (which in some places are triple-tax-free — that is, no federal, state or local income tax applies), investors were happy to buy billions of PR bonds. Just two years ago, $3.5 billion in debt went into the market.

The WSJ also said, “A provisional deal announced Monday with hedge funds holding about $900 million of Government Development Bank, or GDB, bonds showed the lengths that Puerto Rico’s leaders must go to as they wait for Congress to establish a legal framework for a broader restructuring. Under the proposed swap, bondholders would accept new GDB bonds worth about 56% of their original claims. They would exchange that debt yet again, and take a bigger loss, if the island achieves a broader restructuring.”

Naturally, the investors don’t want to get back less than the full amount loaned plus their 8%. That isn’t going to happen, but if Congress passes a law enabling a restructuring along the lines of municipal bankruptcy in the 50 states, they will lose much of their leverage.

On the other hand, “The Treasury and Puerto Rico want a process that makes it easier to restructure debts because this will give the island’s financial advisers more leverage in negotiations with bondholders,” explains the WSJ.

Ultimately, the matter is up to Speaker of the House Paul Ryan to resolve. The bondholders are GOP donors, and they expect their interests to be protected by the party of business. However, the restructuring of the debt is vital because the current economic conditions in Puerto Rico are incapable of meeting the payment schedule.

Europe has shown what happens when an economy unable to meet its debt payments is forced to try. Puerto Rico may well face the future that is the Greek presence, but it needn’t be. Only politics are preventing a different destiny for the island.