Like a gigantic whale lurking beneath a tiny sailboat, Puerto Rico’s debt crisis is massive, problematic, and surprisingly unknown to most. In the span of one week in February of 2014, all three major credit rating agencies downgraded the Commonwealth’s $70 billion in debt to ‘Junk,’ and despite that amount being the third largest in the nation- behind California, New York, and Detroit when they filed for bankruptcy- not much media attention has been paid to the rather startling turn of events.
For such a small landmass, this is quite the feat — just how did it get to this point?
Puerto Rico’s economic woes started in the mid-50s when policies enacted by the United States to transform the island’s mostly agrarian economy into a manufacturing, and touristic one ultimately saw diminishing returns. Those returns came from a decline in salaried employees on the island, along with troves of people who emigrated to the US in search of better prospects. And these trends still exist today.
After a tax-exemption for corporations expired in 2006, companies picked up and left along with many educated Puerto Ricans seeking employment. With so many leaving and those who remain facing a dismal 41% labor participation rate along with a crippling 14.7% unemployment rate, the debt seems an impossible task for the government to handle.
The Puerto Rican people are on the brunt end of this economic mess.
Broken down, each citizen owes $17,000 in debt. Governor Alejandro García Padilla’s attempts to both plug an estimated $800 million budget deficit and reign in the runaway carriage of $70 billion have solely been concentrated on cutting pensions, raising utility costs, selling public assets, cutting the budgets of public services, and large tax hikes.
For the past 13-15 years, Puerto Rico has been digging a deeper and deeper hole by borrowing to pay what it had already borrowed the year before, leading to their current, outrageous debt total which has chained the island to bondholders and creditors without benefiting the local economy whatsoever.
This strategy was tolerated by the financial world despite its inherent instability for a few reasons.
Legally speaking, although states aren’t allowed to operate in this financial manner, under Commonwealth law Puerto Rico can and has done so to sustain themselves.
The island also can’t declare bankruptcy, which is often a last-ditch effort to curb serious debt entanglement.
These issues essentially make Puerto Rico a harpooned whale struggling to stay alive with eager hunters on its tail.
Despite the threat of default looming on the horizon, investors are hungry for fresh debt as the bonds Puerto Rico administers are tax-free in all 50 states on the local, state, and federal levels — making them extremely attractive.
With the Puerto Rican government maintaining the capacity to issue another $3B in debt, hedge funds and investors eagerly await Puerto Rico’s next debt offering this year, and because bondholders have priority in being repaid over retired teachers and doctors, the risk of buying this debt can be mitigated.
Many people are either unaware of what’s going in Puerto Rico, or are choosing to ignore it. A default would not only have serious consequences for those who remain on the island — such as a loss of pensions and other important benefits — but would also issue forth financial repercussions that cannot be easily predicted for the rest of the U.S.
In the event of a default, Puerto Rico can make it so that bondholders are also adversely affected; other states (namely Illinois and Rhode Island) will definitely float this option as well.
Taking this route hopefully won’t allow the many who ride atop the harpooned whale to go down with it, while setting a somewhat more positive precedent, rather than the ‘let’s pay those who got us into this mess’ approach the law currently dictates.
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