Why Puerto Rico matters

It was a nail-biter that went down to the last minute, but Puerto Rico managed to pay its creditors $354 million on Dec. 1. However, the Puerto Rican government raided its January payment to do so. Now, a default is expected next month, and it’s clear that Puerto Rico simply does not have the money to pay its debts over the next five years. What’s at stake is more than whether hedge funds (or anyone who owns certain municipal bond funds) get paid. Puerto Rico, a US territory, is at risk of a humanitarian crisis and any social unrest could spill over to the mainland. Even beyond that, stabilizing Puerto Rico’s finances will require an unprecedented response from the US government that will alter its relationships with states and municipalities across the country.

The Puerto Rican economy is in near free-fall. Last year, 84,000 people left the island, and 1,000 more join them each week, most headed to the US mainland. The island is also experiencing a spike in crime: Since 2011, the amount of cocaine seized traveling through Puerto Rico, most bound for the mainland, quadrupled. Odds are the drug trafficking situation won’t improve if the Puerto Rican economy remains in shambles and it can’t pay its police officers.

There’s plenty of blame to go around for the situation. Puerto Rico ran its economy poorly, with an abundance of shoddy accounting, corruption, and financial mismanagement. Policies from the mainland also hobbled growth. Now, Puerto Rico doesn’t have many good options to reboot. When a country has a debt crisis, it can turn to the International Monetary Fund for debt relief, loans, conditions, and technical expertise to get the economy back on track. Puerto Rico can only turn to the federal government and there’s no legal precedent or money set aside to deal with such a problem. As a US territory, Puerto Rico cannot file for bankruptcy.

At this stage a debt default seems inevitable. Bankruptcy would expedite that process, saving Puerto Ricans and possibly creditors (if litigation drags on) money and time. Indeed, changing the law so Puerto Rico can file for bankruptcy protection was first on Governor Alejandro Garcia Padilla’s wish list when he begged the US Senate for help this week. Filing bankruptcy also makes it possible for the government to write-down pensions that it doesn’t have money to pay.

Governor Padilla is adamant he’s not asking for a bailout, but debt relief won’t be enough. The Puerto Rican economy needs a targeted and well-executed stimulus that includes a heavy dose of involvement from the federal government. If simply spending money or tax incentives were enough to boost growth, Puerto Rico wouldn’t be in this mess to begin with. Federal involvement brings accountability and expertise to the restructuring and rebuilding process.

That involvement might include a federal oversight board the Treasury is proposing or, if necessary, taking more control of the local economy until the foundation is laid for Puerto Rico to prosper. That level of federal intervention is unprecedented in a state or territory. And though Puerto Rico’s economy is in exceptionally bad shape, how its debt crisis plays out will have implications for other municipal bankruptcies. In the past, the federal government did all it could to steer clear of involvement in state and local financial matters, and did not bail out bankrupt municipalities (mainland municipalities can file for bankruptcy, though states cannot). The US government may not have that luxury anymore, not with Puerto Rico and states and cities laden with pension obligations that can’t be paid.

Last year, the Treasury created a department to deal with state and local finances. It signified the federal government playing a more active role in local government. Puerto Rico is just the start.

Allison Schrager

Why Puerto Rico matters