Puerto Rico: Detroit of the Caribbean

Friday marks the one-year anniversary of the grim day Detroit filed a Chapter 9 petition — the largest municipal bankruptcy in American history — and the political and business leaders of New York and other big cities gave a shudder and wondered: Could it happen here?

The disturbing answer is that the next Detroit has already arrived, albeit in slightly disguised form, on a beloved Caribbean island that is a kind of sixth borough of New York City.

Puerto Rico is broke. With an annual budget of $9.6 billion, the government and its affiliated utilities and agencies have collectively racked up $73 billion in debt — far more than it can expect to repay, and some of it at eye-popping rates of more than 9%.

While much of that borrowed money is theoretically backed by future tax receipts, nobody thinks the island’s 3.7 million beleaguered residents, no matter how hard they get squeezed, will come up with the billions needed — which amount to about $20,000 a person. Puerto Rico is already grappling with 14% unemployment, and half the island’s households earn less than $15,000 a year.

Earlier this year, the Moody’s, S&P and Fitch ratings agencies downgraded the island’s debt to junk status, an explicit vote of no confidence in the government’s ability to make future payments on its bonds. As Fitch tersely pointed out, “Bondholders now face a probable financial restructuring or default.”

But Puerto Rico, unlike Detroit, cannot default, thanks to its unique status as a U.S. territory. While cities and counties have been allowed to go belly up since the 1930s, states have always been excluded from the Bankruptcy Code — and, according to the Supreme Court, the U.S. Constitution bars states from walking away from their debts.

Legally speaking, the Commonwealth of Puerto Rico is closer to a state than a city, so it can’t charge off its obligations. That puts Wall Street and the commonwealth on a collision course: The first time major bond payments get missed or restructured — which could happen in a matter of weeks — banks and investment houses will stop extending the money currently being used to keep the commonwealth running.

That, in turn, leads to a script painfully familiar to anybody who lived through the New York City fiscal crisis of the 1970s. Once the money dries up, there will be massive layoffs of public workers and a sharp, even dangerous, decline in services.

The coming catastrophe has persuaded some to vote with their feet: About 1,000 people are leaving the island every week to seek their fortunes elsewhere.

The damage isn’t confined to Puerto Rico. An estimated 66% of municipal bond funds — places where millions of Americans have parked part of their retirement money — are holding Puerto Rico bonds, and will lose some or all of the returns that were expected.

The economic storm now engulfing the island began in 1996, when the Clinton administration began a 10-year phaseout of Section 936, a tax program that had allowed companies to take tax-free profits from operations based in Puerto Rico.

The program was a cornerstone of the island’s economy, responsible for an estimated 1 million jobs by the early 1990s. But hundreds of firms, anticipating the end of the subsidy, gradually began leaving the island, taking tens of thousands of jobs with them.

That trickle turned into a flood when President Bill Clinton’s North American Free Trade Agreement opened U.S. markets to Latin American countries that paid drastically lower wages than Puerto Rico.

A final factor in the current crisis is the irresponsibility of the island’s political leaders and their Wall Street enablers. Pro-statehood island politicians actually encouraged the end of the Section 936 program in the mistaken belief that it would make Puerto Rico more attractive as a possible addition to the U.S. as the 51st state.

The other main faction — anti-statehood leaders who favor keeping Puerto Rico a commonwealth — failed to plan for an economic future without the tax credits, and borrowed to the hilt to make up for lost revenue. Wall Street firms joined in the borrowing binge, running up fee income by selling the bonds as solid investments on the theory that Puerto Rico can’t legally default on payments.

The island has few options now, none of them good. A bailout from the Republican-dominated House of Representatives is out of the question. Nor are Republicans likely to approve statehood for the overwhelmingly Democratic island, since that would add two senators and at least one House member to Congress.

The most likely scenario is a painful period in which public services, property values and economic growth all go into steep decline while an outside body takes control of government spending. Think of it as a kind of tropical Detroit.

Louis is political anchor at NY1 News.

Crushing debt is catching up to the U.S. territory

BY ERROL LOUIS

Puerto Rico: Detroit of the Caribbean