Officials are pleading for patience as a debt-stricken locale scrambles to find a solution to its financial crisis, with investors and onlookers wary about broader repercussions.
But this dilemma, in Puerto Rico, lies thousands of miles across the Atlantic from Athens. And while Greece's financial dysfunction has caught much of the world's focus, Puerto Rico's problems pose interesting questions for the U.S. regarding how it will – or whether it should – help out its territory to the south.
"We might let a city go into default, but not a state. A commonwealth is in a slightly different position," says Robert Shapiro, former U.S. undersecretary of commerce for economic affairs. "But, keep in mind, they're all citizens of the United States. There is a question of political rights. Do the people of Puerto Rico have the same right to have the federal government maintain the basic stability of their home that citizens of Mississippi and California do?"
Puerto Rican officials have until the end of August to finalize economic and fiscal reform proposals that will likely be crucial if the island is indeed unable to repay its outstanding debt, which at $72 billion is estimated to be several times what Detroit's was when it filed for bankruptcy in 2013. And since Puerto Rico, as a U.S. territory, is not eligible to file for Chapter 9 protection under U.S. law, it's sailing in largely uncharted waters and could test the resiliency of the U.S. municipal bond market.
"I don't think either Congress or the Obama administration is willing to stage a bailout," says Mauro Guillén, a professor and director of The Lauder Institute at the University of Pennsylvania's Wharton business school. "The only solution really – at least right now, given that the federal government and Congress don't want to get involved – is for the holders of the debt to meet with a representative from the entities in Puerto Rico that owe the money. … It has to be settled out of the usual channels that you would employ in the United States."
Puerto Rico got itself into trouble by taking on a sizable chunk of municipal bond debt that, in part due to its sheer size and in part due to a series of unfortunate events, ultimately proved to be unsustainable. Municipal bonds, which are often issued by local governments to help fund capital projects, can potentially be taxed at the federal, state or local level in the U.S.
But Puerto Rican bonds are exempt from income taxes at all levels, providing investors with what's called "triple tax exemption."
"They borrowed, they borrowed, they borrowed. But people were looking at the demographics – declining population, an economy that's slowing. You sort of had to see the writing on the wall," Peter Hayes, a managing director and head of the municipal bonds group at BlackRock Inc., said in a recent interview on Bloomberg's "Market Makers."
Puerto Rico took on billions of dollars in loans by issuing bonds to investors, and all was well until about 1996, when a tax credit that drew substantial investment from the mainland was scheduled to be phased out. That possessions tax credit allowed corporations to set up shop in Puerto Rico and ship goods over to the continental U.S. relatively inexpensively, but it was also criticized for doing more for U.S. companies than Puerto Rican workers.
"The factories they built were very advanced, and, consequently, highly automated. They produced very little employment, and the profits were all transferred back to the U.S. This had been a flawed policy for a long time, but it was kind of what they had," says Shapiro, now chairman of the advisory firm Sonecon. "The fact is, Puerto Rico has had a long, flawed model of economic development in which it has depended upon a set of provisions which have now been phased out."
The credit officially expired in 2006, and with it went many corporate investments, essentially starting a domino effect that toppled much of the Puerto Rican economy. The onset of the Great Recession shortly thereafter only exacerbated the situation.
"Now they find themselves in a position where they don't have the money to meet their obligations when they come due," Guillén says. "The government hadn't laid the foundations for sustainable growth for the long run, which would have required investments in infrastructure, education."
Sale signs hang in the windows of a store in in San Juan, Puerto Rico, on June 30, a day after the island's governor, Alejandro Garcia Padilla, gave a televised speech regarding the government's debt burden.
"After growing continuously for almost two centuries, Puerto Rico's population declined for the first time in 2006, and has since shrunk from its peak to about 3.5 million in 2015," said a recent report commissioned by the Puerto Rican government and conducted by three former International Monetary Fund economists. According to the report, officials expect the population decline to continue through 2020 – even without further economic strife.
Among island-born Puerto Ricans who left for the U.S. between 2006 and 2013, 42 percent cited job-related reasons for why they were leaving, according to the Pew Research Center, whose researchers also noted that Puerto Rico's falling fertility rate is another driver of its population decline. The number of children estimated to be born to a woman on average in Puerto Rico was 1.3 in 2013, down more than 31 percent from roughly a decade earlier.
"Historically, fertility has dropped during economic recessions," Pew researchers said.
Puerto Rico's situation additionally hasn't been helped by the shrinking pool of individuals who aren't leaving the island but also aren't participating in the domestic labor force. The 1.1 million Puerto Rican citizens working or actively looking for a job in May equated to about 79 percent of the commonwealth's May 2006 labor force, according to a recent report by the Puerto Rico Planning Board. Puerto Rico's labor force hasn't seen year-over-year growth in any month since February 2008.
"Workers are disinclined to take up jobs, because the welfare system provides generous benefits that often exceed what minimum wage employment yields," the report conducted by the former IMF economists said.
In terms of gross domestic product, when chaining the data to 1954's dollar value to filter out inflation, Puerto Rico's economy has grown in only one year out of the last 10 – a result of its web of connected problems. In short, it's difficult for Puerto Rico to repay its debts without economic growth, and it's difficult to generate economic growth when labor force participation is low and people are leaving en masse.
"It has the lowest labor force participation rate in the Western Hemisphere. That means all those small Latin American countries – we're worse. It's worse than Haiti. Its unemployment is over 13 percent," Shapiro says. "Business investment in Puerto Rico has been growing at half the average rate as the rest of the Caribbean. This is systemic economic mismanagement and underperformance for a decade."
So what can Puerto Rico do?
"They have all this debt that they can't afford. How do you get out of debt?" Hayes said. "You either grow your way out – they're not growing – or you restructure."
Even if possible, a straight-up government debt repayment would be tricky, because a big chunk of Puerto Rico's money is tied up in budgetary commitments aimed at benefiting citizens and taxpayers. That means if the commonwealth decided to just throw all of its resources into debt repayments – likely limiting social assistance programs in the process – its more than 3 million citizens would ultimately lose out. Such a move is often politically perilous as well, with unpopular austerity measures serving as a major source of contention in Greece's debt negotiations with its own creditors.
The Puerto Rican government also could potentially turn to the overarching U.S. government for financial assistance, though the White House already has quashed talk of a federally funded bailout.
"There's no one in the administration or in D.C. that's contemplating a federal bailout of Puerto Rico," White House spokesman Josh Earnest said last month. "But we do remain committed to working with Puerto Rico and their leaders as they address the serious challenges."
Some on the island and in Congress instead have called to extend eligibility for Chapter 9 bankruptcy protections to Puerto Rico – a move that essentially would treat the island like a U.S. state by granting it the authority to permit its municipalities and public utilities to enter Chapter 9 proceedings, giving them a clearer framework for restructuring their debts.
Democratic Sens. Richard Blumenthal of Connecticut and Chuck Schumer of New York last week unveiled legislation aimed at accomplishing that.
“This measure is vital to prevent a humanitarian and financial catastrophe – a clearly avoidable disaster,” Blumenthal said. “Creditors, investors, ordinary citizens, all will be harmed if the Congress fails to act."
Still, such an option faces an uncertain fate in Congress, particularly among wary House Republicans.
“It’s as if Puerto Rico is the Western Hemisphere Greece,” Rep. Steve King, R-Iowa, said earlier this month, according to Politico. “They refuse to accept austerity. They refuse to take the issue on.”
Meanwhile, the option that's currently being pursued by the Puerto Rican government is to reach some sort of debt restructuring agreement with its creditors, potentially involving a move known as a "haircut" that would essentially slash investors' returns. Creditors would get something back, but it would fall short of their initial investment.
"From a debt sustainability level, they have about $72 billion in debt. They need to get down to about $40 billion," Hayes said, noting that he predicts about 40 percent of Puerto Rico's debt will need to be forgiven and cut for it to get on a more sustainable path. "At the end of the day, they probably say, 'Look, we're not paying debt service. So if we're not going to pay debt service, you'd better come to the table and negotiate.'"
It's been difficult not to draw comparisons between Puerto Rico's debt crisis and the one in Greece, as negotiations between the cash-strapped Mediterranean country and its European creditors dragged on for months. Puerto Rico, however, is actually in better shape than Greece is, considering its amount of debt is pocket change compared with Greece's $323 billion.
Germany's finance minister, Wolfgang Schäuble, even joked earlier this month that he'd be willing to trade Greece to the U.S. for Puerto Rico.
"I offered my friend [Treasury Secretary] Jack Lew these days that we could take Puerto Rico into the eurozone if the U.S. were willing to take Greece into the dollar union," he said in Frankfurt.
Still, Shapiro says the two situations are similar in that, as Greece tested the unity of the European Union, Puerto Rico could ultimately test to what degree the U.S. will act to keep its states and territories solvent.
"Puerto Rico is, like Greece, not large enough to affect the macroeconomy of the United States, as Greece is not large enough in itself to affect the macroeconomy of the [European Union]," Shapiro says. "At the same time, however, it sends a powerful message. … So the question is, 'OK, Fannie and Freddie were too big to fail. Is Puerto Rico too big to fail?'"
By Andrew Soergel
The U.S. territory is in uncharted waters and looking for a lifeline.
Is Puerto Rico Too Big to Fail?
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