Puerto Rico's Debt Crisis: Overview

Introduction

In 2016, the US territory of Puerto Rico owed over $70 billion to corporate and individual bondholders and other types of investors. To address the fiscal crisis, the US government passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). PROMESA aims to restructure Puerto Rico's debt but does not eliminate it. Debt restructuring provides more time to pay debts, but also means negotiating with creditors to pay a certain percentage of the debt instead of the full amount.

Puerto Rico's status as a territory means that it does not have the same laws or privileges as a US state or municipality. It also lacks the sovereignty of an independent nation. As a result, its debt cannot be handled in the same way as the debt of an American city like Detroit, which filed for Chapter 9 municipal bankruptcy. Detroit defaulted on its debts, and its investors experienced huge financial losses. Puerto Rico is also different from an independent nation like Greece, which could receive aid from the International Monetary Fund and other organizations during its financial crisis.

Puerto Rico's financial crisis affects government, corporations, and individuals. The island owes money to investors and bondholders who lent money to Puerto Rico with the expectation of being repaid with interest. Further, pension accounts have been used to pay the debt, which means that there may not be enough money to pay out funds owed to Puerto Rican workers. The poverty rate was close to 50 percent by 2016, and unemployment was at least 12 percent as of 2017. Many Puerto Ricans have been leaving the island for the US mainland, and education, health care, and public safety on the island have suffered under austerity measures. Jubilee USA Network, a nonprofit that assists developing countries with achieving economic stability, has called Puerto Rico's situation a "humanitarian crisis." Debate surrounds how Puerto Rico can recover economically and whether its debt should be canceled under the circumstances.

Understanding the Discussion

Bond: A type of investment that provides money to entities (usually governments) who need funds and will repay them with interest on a particular maturity date.

Bondholder: A corporate or individual investor who purchased municipal bonds.

Debt restructuring: Often a court-supervised process in which borrowers and investors negotiate repayment when the borrower is unable to pay in full or in a timely manner.

Municipal bankruptcy: Also known as Chapter 9, a process that protects the assets and resources of insolvent cities or states from their creditors while debt is negotiated.

Sovereignty: The ability to govern oneself without the imposition of laws from another governing body.

History

Understanding Puerto Rico's history is key to understanding how it reached the point of financial crisis, why restructuring Puerto Rico's debt is a fraught process, and why the various stakeholders disagree about how to move forward. The steps leading to accumulating debt were multifaceted and complex and had to do with broader economic policy in addition to straightforward borrowing.

Puerto Rico's commonwealth or territorial status sets it apart from both US states and independent nations. Puerto Rico became a territory of the United States after the Spanish–American War of 1898. The Foraker Act of 1900 established a civilian government on the island, but it was not until 1901 with the Downes v. Bidwell case that the Supreme Court defined Puerto Rico's status, specifying that it was not part of the United States but rather a possession. In 1917, the Jones Act granted US citizenship to anyone born in Puerto Rico after the United States took possession of the island, but the act did not include congressional representation or total self-government. While Puerto Ricans are US citizens and can serve in the armed forces, they cannot enjoy the full benefits of citizenship unless they relocate to a US state (which many do). Further, Puerto Rico's government has limited power to enact laws, and it is the US Congress that has enacted much of the economic policy that has governed the island since the United States took possession.

At the time of the Spanish–American War, coffee constituted 76.9 percent of Puerto Rico's exports. But in the years following US possession of the island, land ownership became more concentrated, and sugar plantations supplanted coffee. By 1930, Puerto Rico's coffee industry was almost nonexistent. The sugar industry suffered during the Great Depression, and neither sugar nor coffee rebounded. The faltering agricultural sector set the stage for a number of economic policies in the mid-twentieth century, policies that would have a long-lasting effect on the diversity and sustainability of Puerto Rico's economy.

As agriculture faded as a viable industry, the US Congress took action to shift Puerto Rico to industry with the 1947 Industrial Incentives Act (also known as Operation Bootstrap), which provided economic incentives for industry to set up shop in Puerto Rico. These incentives included low taxes and inexpensive labor. Many companies relocated to Puerto Rico because they could realize greater profits there. One consequence of the Industrial Incentives Act was that many Puerto Ricans left rural areas and migrated to cities or to the mainland United States. While the act did boost Puerto Rico's economy, it reduced diversity in types of industry and began a trend of migration to the mainland US. In 1976, a further incentive, Section 936, stipulated that companies operating in Puerto Rico did not have to pay federal taxes. The gains from the Industrial Incentives Act waned with the North American Free Trade Agreement (NAFTA), which came into force in 1994. NAFTA made it more cost-effective for companies to operate in Mexico, and Puerto Rico therefore did not have the same allure as before. In 1996, Section 936 was repealed, which meant that companies had even less incentive to be on the island.

The various economic policies during the twentieth century first lessened the viability of agriculture and then the viability of industry. These changes were voted upon by the US Congress. While the 1950 Puerto Rico Federal Relations Act allowed Puerto Rico to form its own government with its own constitution, the United States still had control over many aspects of the law, including citizenship, trade, and diplomacy. The United States could also change Puerto Rico laws that it found inconsistent with the US Constitution. This duality is one of the factors rendering Puerto Rico's debt a contentious matter.

Changes wrought through 1990s policy caused a downturn in industrial investment in Puerto Rico. By 2006, the island was facing a fiscal crisis. A 1984 law passed by Congress excluded Puerto Rico from standard Chapter 9 municipal bankruptcy procedures, and Puerto Rico has therefore had to use different strategies for handling its economic situation. To maintain essential services, Puerto Rico issued government bonds, which investors bought with the expectation that Puerto Rico would recover and pay the money back with interest. These bonds, however, increased Puerto Rico's debt load, and the economy did not recover as hoped. Since the decline of industry, no equivalent, sustainable economic base has entered the picture. While tourism was a growing industry in the early twenty-first century, the rise of the Zika virus put a damper on that sector of the economy.

Puerto Rico's Debt Crisis Today

In April 2016, Puerto Rico declared a fiscal state of emergency. The government halted debt payments in order to channel more funds toward essential services, such as health care and schools. Since Puerto Rico cannot file for Chapter 9 municipal bankruptcy, in July 2016, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) to help Puerto Rico restructure its debt. PROMESA provides a seven-member oversight board appointed by the United States, including four representatives from Puerto Rico. PROMESA employs Title III, a court-supervised process similar to bankruptcy. It aims to negotiate debts with creditors, but if those negotiations fail, Congress will dictate the terms of restructuring the debt. PROMESA also institutes measures meant to aid economic recovery, such as lowering the minimum wage for young workers.

In September 2017, Puerto Rico suffered an additional blow to its economy when Hurricanes Irma and Maria hit the island, causing flooding, blackouts, and loss of access to food and clean water. The US Federal Emergency Management Agency (FEMA) delivered aid, but that aid was targeted for specific tasks, and many supplementary recovery expenses fell to Puerto Rico itself. These expenses include resuscitating the bankrupt Puerto Rico Electric Power Authority.

In 2018, Puerto Rico owed over $70 billion in public-sector debt. For comparison, the city of Detroit presented debts of $18.5 billion in bankruptcy proceedings. Puerto Rico's borrowed funds have come from hedge funds and other investors who purchased municipal bonds. The bonds provided funds that Puerto Rico was expected to repay. Puerto Rico's debt falls roughly into two basic categories: general obligation debt (GO) and Corporación del Fondo de Interés Apremiante (COFINA) debt. The two types of debt differ in how they are repaid and to some degree in who purchased the bonds. The Puerto Rico Constitution specifies that GO debt should be paid off before other types of debt, and it should be paid by any means necessary, including raising taxes on residents. COFINA debt, on the other hand, consists of revenue bonds, which means that money used to repay it is generated through sales taxes. Each type of bondholder argues that they should be the ones to receive any available funds for repaying debts. COFINA, despite being created by the Puerto Rican government, disagrees with the commonwealth about how debts should be repaid. COFINA has an obligation to its bondholders, but the commonwealth prioritizes providing essential services to the populace. Further complicating the debate, some economists, politicians, and nonprofits believe the best means for Puerto Rico to recover economically is for its debt to be canceled altogether.

These essays and any opinions, information, or representations contained therein are the creation of the particular author and do not necessarily reflect the opinion of EBSCO Information Services.

About the Author

J. D. Ho received an MA in literary and cultural studies from Carnegie Mellon University. She has worked on academic diversity initiatives, including projects to encourage minorities in STEM fields, and has written about Puerto Rico's importance in the field of astronomy.

Bibliography

Duany, Jorge. Puerto Rico: What Everyone Needs to Know. Oxford UP, 2017.

Jubilee USA Network. "Puerto Rico's Debt Crisis: A Timeline." Jubilee USA, 2017, www.jubileeusa.org/puerto‗rico‗s‗debt‗crisis. Accessed 7 Apr. 2018.

Levin, Jonathan, and Yalixa Rivera. "Puerto Rico's Daunting Job Market Has Weary Workers Surrendering." Bloomberg, 9 Apr. 2018, www.bloomberg.com/news/articles/2018-04-09/puerto-rico-s-daunting-job-market-has-weary-workers-surrendering. Accessed 10 Apr. 2018.

United States. House Committee on Natural Resources. Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). Government Printing Office, 2016. House Committee on Natural Resources, naturalresources.house.gov/uploadedfiles/promesa‗packet‗6.6.pdf. Accessed 7 Apr. 2018.