Puerto Rico’s MASSIVE Debt Is ‘Unprecedented Test’ Of US Municipal Bond Market

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Peter Fricke Contributor
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Puerto Rico Gov. Alejandro Garcia Padilla says the territory is unable to pay off its $72 billion debt, and will deliver a speech Monday night outlining possible solutions.

Puerto Rico’s per capita debt burden is larger than that of any American state, and Garcia Padilla has indicated that he will ask creditors to accept a restructuring of the debt, such as deferring payments or extending repayment schedules, according to The New York Times.

“The debt is not payable,” Garcia Padilla said in an interview. “I would love to have an easier option,” he added, but “This is not politics. This is math.” (RELATED: Congress Could Make US Retirees Shoulder Puerto Rico’s Debt)

The Times called Puerto Rico’s scenario an ‘unprecedented test’ for the U.S. bond market, the same one states and cities use for infrastructure and development projects.

As a territory, Puerto Rico does not have the option of declaring bankruptcy, as states do, and so must either work out a deal with creditors or face the prospect of default, which would likely trap Puerto Rico in a long-term debt crisis.

The island’s troubles are a direct result of its shrinking economy, which took a major hit when corporate tax breaks expired in 2006, leading to the departure of pharmaceutical companies and other manufacturers, according to The Wall Street Journal.

As the declining economy cut into tax receipts, the government made up for the shortfall with increased borrowing, taking advantage of a federal law exempting Puerto Rican bonds from federal, state, or local taxation. Currently, the island has a debt-to-GDP ratio of about 70 percent, compared with an average of about 10 percent among U.S. states.

At the same time, citizens have been emigrating from the island, further reducing the tax base. Since 2010, the population has declined by 4.7 percent.

According to the Puerto Rico Fiscal Stability Coalition, the Commonwealth’s burgeoning debt load could necessitate a taxpayer bailout of Puerto Rico, which they estimate would cost up to $164 billion. (RELATED: Republicans Abandoning Principles in Bailout for Puerto Rico)

To prevent that, Puerto Rico’s non-voting delegate to the U.S. House of Representatives, Democratic Rep. Pedro Pierluisi, proposed H.R. 870 in February, which would define Puerto Rico as a “state” in the context of allowing its municipalities and public corporations to file for Chapter 9 bankruptcy. (RELATED: Grover Norquist to Push for Statehood for Puerto Rico)

The mood in Congress, however, does not seem conducive to allowing either bankruptcy or bailout, meaning some form of restructuring is likely the only option for avoiding default.

“We don’t expect the federal government to come to the rescue,” Ted Hampton, an analyst at Moody’s Investors Service, told The WSJ. “It would really raise a lot of questions.”

In his speech Monday night, Garcia Padilla is expected instead to endorse proposals contained in a government-commissioned report by former International Monetary Fund staffers, Reuters reports.

In addition to pursuing “a voluntary exchange of old bonds for new ones with later or lower debt services,” the report also calls for government-wide spending cuts, tax increases, and reforms designed to make the Puerto Rican economy more competitive.

The government could save about $900 million by 2020, for instance, by reducing university subsidies and cutting the number of teachers to better reflect the 40 percent decline in students over the last decade.

At the same time, the report recommends “the introduction of a sales tax proposed by the current administration could yield $1 billion a year from 2016,” and suggests increasing property taxes by about $100 million per year, noting that the tax is currently assessed based on property values from 1954.

Finally, the report calls for suspending the minimum wage “until Puerto Rico’s per capita income reaches that of the poorest U.S. state,” and cutting the number of holidays for public workers from 30 days per year to 15 days.

Garcia Padilla indicated that creditors will have to “share the sacrifices” imposed on Puerto Rico’s citizenry, saying, “If they don’t come to the table, it will be bad for them.”

“What will happen is that our economy will get into a worse situation and we’ll have less money to pay them,” he explained. “They will be shooting themselves in the foot.”

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