As the Europeans bungle their way toward a default by Greece on an IMF payment due today, the governor of the American Commonwealth of Puerto Rico has announced that the island possession can’t pay its $72 billion public debt. Governor Alejandro Garcia Padilla was blunt in calling for concessions from creditors, “The debt is not payable. There is no other option. I would love to have an easier option. This is not politics, this is math.” He also used the words “death spiral.” The parallels with Greece are there, but no one is demanding that Puerto Rico give up the dollar and establish its own currency. That would be dumb.
Puerto Rico is in a strange position constitutionally; it is not does not have the status of state (e.g., California, Texas or Wyoming), nor is it organized as a territory preparing for statehood (as most of the states were at one stage in history). Taken from Spain as part of the settlement of the Spanish-American War, Puerto Rico is called a commonwealth but that term does not appear in the Constitution. While Kentucky, Massachusetts, Virginia and Pennsylvania refer to themselves as commonwealths, in truth, this has no legal meaning. They are states for legal and political purposes, quite different from Puerto Rico’s position. Since 1917, Puerto Rico’s Spanish-speaking inhabitants have had US citizenship, but they do not choose electors in the presidential elections nor do they send voting members to the Congress. This legal limbo is part of the problem.
Most of the problem, however, stems from bad government, a weak economy and rapacious bankers. The economy has not grown since 1996, and last year, 36,000 people left the island to live elsewhere, a trend that goes back quite some time. The government has spent far beyond its tax-base’s means, and Wall Street was only too happy to loan money to the government. The killer development, however, was the North America Free Trade Agreement that undermined the island’s status as a corporate haven. Each month, the government must set aside $93 million for debt service, which under the local constitution is the senior-most financial obligation. The bonds are rated as junk.
Under American law, municipalities can file for bankruptcy. Detroit, Michigan, and Stockton, California, have done so. However, state governments cannot. Puerto Rico is neither a municipality nor is it a state. It will probably take an act of Congress to define what options the island has in law. There is certainly no legal framework under which the US government can bail it out at present.
Governor Garcia Padilla isn’t waiting around for that to happen. He has said that the creditors must “share the sacrifices” with the Puerto Ricans. “If they don’t come to the table, it will be bad for them. What will happen is that our economy will get into a worse situation and we’ll have less money to pay them. They will be shooting themselves in the foot.”
Some of the creditors have already seen the light, realizing that partial payment is better than no payment. The New York Times reported, “Late last week, Puerto Rico officials and creditors of the island’s electric power authority were close to a deal that would avoid a default on a $416 million payment due on Wednesday.”
Nevertheless, Congress may want to pass a law to allow the island to declare bankruptcy. Puerto Rico recently hired Steven W. Rhodes, the retired federal judge who oversaw Detroit’s bankruptcy. He said, “There are way too many creditors and way too many kinds of debt. They need Chapter 9 for the whole commonwealth.”
The impact that the $72 billion in debt will have in the event of a default will be felt across America. Most of the debt is held by private, American investors in municipal bond funds, attracted by their triple tax-free structure.