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Plan to Solve Puerto Rican Debt Crisis Already Off the Rails

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Efforts to solve the Puerto Rican debt crisis have already run off the rails.

Late last month, Congress passed a bill allowing Puerto Rico to restructure its debt. Under the plan, the US territory essentially declared bankruptcy. The US government won’t expend funds to bail out Puerto Rico, but will allow the island’s government to pay back debtors at less than 100%. Although the bill doesn’t say so explicitly, for all practical purposes it created a bankruptcy process for the island.

Even with the agreement, Puerto Rico still defaulted on a $1.9 billion payment in principle and interest that was due July 1. Under the Puerto Rican constitution, bondholders were supposed to get first claim on government funds. At the time, 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.

Fast forward to today and we find the Congressional fix has already started to unravel. The congressional plan put Puerto Rico under the guidance of a federal oversight board. But the law featured a built-in lag of at least two months before the board is put in place. Meanwhile a group of hedge funds have sued the country. They claim Gov. Alejandro García Padilla is exploiting the lag by spending hundreds of millions of public dollars on “purposes that apparently enjoy political favor,” According to the New York Times:

One of the biggest government outlays cited in the lawsuit was $800 million that was transferred to Puerto Rico’s pension system for public employees. An additional $250 million was apparently used to prop up the Government Development Bank for Puerto Rico, which was declared insolvent last year. In normal times, the bank is a major player in the island’s economy, managing the government’s cash, structuring its debts and making loans to selected private businesses, among other duties. The lawsuit also claimed that $2.5 million had been improperly used to cover a year’s worth of spending by the Office of the First Lady, and an additional $1.2 million went for ‘development of high-performance Puerto Rican athletes.’ And some $800 million was headed for the University of Puerto Rico, the lawsuit said, ‘to maintain artificially low tuition rates, well below what comparable state universities in fiscally balanced states charge.’”

The lawsuit argues the oversight board would have challenged the spending and that holders of Puerto Rico’s general obligation bonds have first rights to the money.

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Other lawsuits are expected. The governor’s chief of staff said the government will aggressively fight them:

To be clear, creditors suing the commonwealth will not receive special treatment or secure additional leverage. Such litigation is pointless and counterproductive. It poses an obstacle to the orderly restructuring of government debts, and only serves to strain resources that might otherwise be devoted to a voluntary resolution.”

It comes as no surprise that these hedge funds have resorted to legal action. They are the parties likely to get the short end of the stick as Puerto Rico tries to extricate itself from its debt crisis. Remember, the law passed by Congress allows the country to pay back bondholders at less than 100%.

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.”

It’s important to look at the fiasco through a broader lens. In many ways, Puerto Rico s a microcosm. Many countries face even worse debt problems than Puerto Rico. We will likely see similar scenarios playing out around the world. Just today, US Treasury Secretary Jacob Lew stressed the importance of making Greece’s debt sustainable:

Putting Greece’s debt on a sustainable path is critical to Greece’s long-term economic health and I encourage all parties to be flexible to successfully conclude this fall’s negotiations…Our position has been clear for quite some time that it’s important for debt restructuring to be part of an overall plan for Greece.”

“Debt restructuring” is code for some people aren’t getting paid back all that they’re owed.

And the truth of the matter is the US is arguably in worse financial shape than Puerto Rico. The only difference is government officials and central bankers in America can kick the can down the road through monetary policy and money printing. The problem is, eventually the can runs out of road.

The bottom line is that at some point, the US and many other countries will have to face the mountain of debt, just like Puerto Rico is today. When that happens, the ramifications will be far-reaching.

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One thought on “Plan to Solve Puerto Rican Debt Crisis Already Off the Rails

  1. Gloria says:

    Puerto Rico needs a complete re-do. It is corrupted, everything under the table, key charges, ignorance. As beautiful as the island is, it is a financial disaster. Gone are the years of Gov Luis Munoz Marin and Opetation Bootstrap. Those were good times for the island. I don’t know what will happen to La Isla del Encanto.

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