Congress Passes Rescue Bill But Puerto Rico Will Still Default

Even with Congress giving final approval to a bill that will allow Puerto Rico to restructure its debt, the US territory will default on a $13 billion general-obligation debt on July 1.

A $1.9 billion payment in principle and interest is due Friday. Puerto Rico will renege on the payment to bondholders despite a constitutional provision that says the debt has top-claim on the government’s funds. Puerto Rico Governor Alejandro Garcia Padilla said the commonwealth could not raise enough money to cover the payment even if he completely shut down the government.

As Bloomberg pointed out, Puerto Rico’s inability to make the payment shows just how bad the situation is:

The default signals the depths of the crisis on the island, which had been tapping whatever funds it could to avoid missing payments on securities backed by the strongest legal pledge…It would be the first payment failure from a state-level borrower on debt backed by the full power to raise taxes since Arkansas’s in 1933. Since August, Puerto Rico had already defaulted on debt issued by three agencies, including the Government Development Bank, though creditors were left with little recourse because the securities were backed by weaker legal safeguards.”

Meanwhile, after months of wrangling, Congress sent a bill to President Obama’s desk that could help Puerto Rico work its way out of its debt crisis. It will allow the territory to essentially declare bankruptcy. It won’t expend federal funds to bail out Puerto Rico, but will allow the island’s government to pay back debtors at less than 100%. For all practical purposes, it creates a bankruptcy process for Puerto Rico, even though you won’t find the word “bankruptcy” in the bill’s language. According to the New York Times, the legislation will not cost US taxpayers a dime. But it may leave investors in Puerto Rican bonds holding the bag:

The rescue package will not prevent Puerto Rico from missing the payment due on Friday on a $2 billion debt, and Republican congressional leaders labored to the end to reassure conservatives that the bill is not a bailout. Instead, the legislation would allow the island’s government to restructure its $72 billion total debt so it can manage payments, and create a bipartisan oversight board mostly of outsiders to guide what is sure to be a painful recovery process. Crucially, given the imminent missed debt payment, the bill also would bar lawsuits by creditors for nonpayment retroactive to December — to provide Puerto Rico ‘the breathing room,’ as Mr. Lew put it, for its government and the control board to restructure the crippling debt and devise a new budget plan.”

Passage of the rescue bill was in doubt in the Senate due to some Democratic opposition to Republican provisions setting a lower minimum wage for young workers and limiting overtime pay on the island. Ironically, US imposition of mainland minimum wages was part of what drove Puerto Rico into its current economic chaos.

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There was also opposition to offering Puerto Rico the possibly of giving bondholders a haircut. But Peter Schiff has argued this was the only truly moral way forward because people who took the risk and bought the debt should have to pay for their mistake, not the US taxpayer:

If Puerto Rico is allowed to be restructured, they won’t need a bailout because the hedge funds will be the ones to lose. They’re trying to make it out like it’s mom and pops who are going to be the losers. No, no. It will be these wealthy hedge funds that are going to lose out. But they need to lose out, because they never should have bought these bonds.”

Bloomberg said  the Puerto Rican crisis hasn’t triggered broader contagion in the US municipal-bond market because investors view Puerto Rico’s problems as unique. But as we reported back in May, Puerto Rico is just the tip of the iceberg:

Investors have long-considered sovereign debt a ‘safe’ investment. But in a sense, they were ignoring reality. Loaning anybody money carries with it some level of risk. A guarantee to repay is only as good as economic realities surrounding it.”

And despite what the pundits and government officials keep saying, the economic realities appear pretty bleak.

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