Puerto Rican Bankruptcy Sets A Horrible Precedent

REUTERS/Nick Brown

Derek Hunter Contributor
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Democratic Congressman Hank Johnson once famously worried sending too many US troops to Guam, especially if they were at one end of the island, might cause it to tip over. Seriously, he said that. While Guam, and every other island for that matter, doesn’t run the risk of flipping like a coin, on island is about to go under – Puerto Rico.

The US territory is broke; bankrupt, actually.

On May 3rd, Ricardo Rossello made the decision to officially declare bankruptcy. The island owes a crushing $123 billion, consisting of “$74 billion in debts and $49 billion in pension liabilities,” according to USA Today.

The World Bank pegs Puerto Rico’s gross domestic product at $103 billion, meaning the island has managed to obligate itself well beyond the value of everything it produces. With a shrinking population, which has fallen by roughly 10 percent in the last decade, the prospects for recovery are non-existent.

How a US territory goes about declaring bankruptcy has never been an issue, and was an impossibility until a news law was passed in 2016 with Puerto Rico in mind.

Governor Rossello declared Title III bankruptcy and Chief Justice John Roberts appointed a judge from New York to oversee the procedure.

But what should happen now?

Until Puerto Rico’s declaration, the largest municipal bankruptcy in US history was Detroit in 2013. But that was only $18 billion, just 1/7th what Rossello faces.

Last year, when Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), it created a 7-person oversight board to managed Puerto Rico’s finances. Chapter III bankruptcy was supposed to be a last resort. Apparently that last resort has been reached already.

The new law imposed a moratorium on creditors taking legal actions against Puerto Rico, but that moratorium expired May 1st. As soon as it expired, some creditors started to take legal action to recoup what they are owed. That’s when Governor Rossello pulled the parachute of Chapter III.

This is where it gets dangerous.

Allowing Puerto Rico to move forward to dissolve much of its debt at the first available moment short circuits a process that has barely started. More importantly, it sets a horrible precedent for future state and municipal bankruptcies looming in the near future.

Many states and cities are racking up huge unfunded pension liabilities they have no conceivable hope of meeting. While Puerto Rico has total obligations of $123 billion, the state of Illinois “has about $130 billion in unfunded pension obligations alone,” according to the Chicago Tribune.

Calling Puerto Rico “the frightening ghost of Illinois future,” the Tribune warns bankruptcy for the state is “a theoretical solution no one should wish for because of the pain and chaos it would create. If bankruptcy protection became an option, bondholders would charge punishing interest rates, or quit buying Illinois bonds, because of the increased risk that the state couldn’t make its interest payments. Just the specter of Puerto Rico is chilling.”

But Puerto Rico can only be a “chilling” warning if it is allowed to fully implode and go through bankruptcy. It should be allowed to, at least not yet.

State and territorial governments need access to credit to meet their financial obligations, their revenue comes in periodically while their payroll, for example, has to be met more regularly. Going through Title III bankruptcy would make getting credit nearly impossible for Puerto Rico, at least at manageable rates, which would negate one of the main purposes of PROMESA, the help Puerto Rico.

This is to say nothing about the damage to creditors, which could impact the economy, pensions, etc. The United States would survive a Puerto Rican abdication of responsibility, but it could end up being just the first in a string of dominoes to fall.

Last year the Mercatus Center identified 9 states with nearly $2.5 trillion in debt and unfunded liabilities it would take a miracle for them to meet if they continue their current policies and spending. If Puerto Rico is allowed to speed down the bankruptcy path, there’d be nothing to stop any of the from following. That would have a major, negative impact on the nation’s economy.

Bankruptcy may have to be an option, but it should be one of absolute last resort. Puerto Rico will serve as the example going forward, that’s why they should be all but forced to work every other possible option first.

They need comprehensive structural reform in how their government does what it does, and vigorous, good-faith negotiations with their creditors, which have yet to take place. And, frankly, some pain for their irresponsibility that led them to this point. They need to be the example to ward other states off their dangerous, irresponsible path. Allowing them to be absolved of their responsibilities will only cause others to seek the same treatment, and that would be devastating.