The tragedy of Puerto Rico, America's very own Greece

The eyes of the world are trained on Greece, this week, as it teeters on the brink of disaster. Which perhaps helps to explain Alejandro García Padilla’s timing: the Puerto Rico governor chose Monday to announce that the island territory is insolvent, and cannot (will not) pay back its $72 billion in debt. Not on time and in full, in any case.

Like Greece, Puerto Rico’s economic problems aren’t new, and they aren’t likely to be resolved anytime soon. The Puerto Rico government recently asked a team of former IMF economists to write a report on the country, which makes for extremely depressing reading. The big economic picture is downright scary:

And then comes a litany of lowlights:

• In 1996, the US government repealed Section 936 of the Internal Revenue code, which gave tax breaks to mainland companies operating on the island, with predictable results: the Puerto Rican economy started shrinking in 2005, right as the 10-year phase-out period for the tax breaks ended.
• Home prices have fallen by 38% from their 2010 peak. That’s very bad news in a territory where almost everybody has weak credit, and so borrowing against real estate is just about the only way to raise fresh capital.
• The island’s banking sector is in crisis, and shrinking even faster than the economy as a whole, which means that it can’t boost lending to fuel a recovery.
• Just 40% of Puerto Rico’s adult population is either employed or looking for work.
• The population of Puerto Rico has already shrunk by about 10% in the past 10 years, and is going to keep on shrinking by about 1% per year at least until 2020, which means ever-fewer people supporting an ever-rising debt burden.
• The island is incredibly poorly run: it never sticks to its budgets, and its statistical agencies are so weak that almost no one knows for sure just how bad its finances really are.
• The Jones Act forces all of Puerto Rico’s imports to be delivered on US-built and US-owned ships with US crews, sailing under the US flag. This significantly increases the prices of goods on the island, where the cost of living is nearly as high as it is in cities like New York. Meanwhile, wages on the island are much lower than anywhere else in America, with per capita income of less than $24,000 per year. (The poorest US state, Mississippi, has income of $37,000 per person per year, while the richest, Maryland, is over $70,000.)

In fact, the situation in Puerto Rico is even worse than the report lets on. Nothing is more fundamental or important than clean drinking water, but even that is in such short supply that the capital, San Juan, has been forced to implement drastic rationing measures. Residents of the city have their water cut off entirely for 48 hours every three days; people who live nearby are better off, having to go without water just for 24 hours every other day.

Puerto Rico, like Greece, is the poor southern cousin of a politically-motivated monetary union which was not designed with such populations in mind. Like Greece, it is burdened with a massive debt it can’t realistically pay back. Like Greece, it is therefore going to default. And like Greece, that default is going to prove extraordinarily painful, in large part because of the constraints being imposed from the north.

The big question in Puerto Rico is what’s going to happen to its debt. Various different Puerto Rico government agencies have in total borrowed more than $70 billion from investors, mostly individuals in the United States who own municipal bond funds. Once Puerto Rico stops paying those creditors, they (or their bond insurers) will head straight to court to get their money back.

That will set up a zero-sum fight between the debtor and the creditors, just like any other default situation. But Puerto Rico’s case is different from most other debt defaults. After all, debtors generally have some protections. Most bankruptcy laws, for instance, protect debtors’ assets and incomes from being seized, at least temporarily. And in the case of sovereign nations like Greece, it’s almost impossible for any court, foreign or domestic, to force the country to pay monies it doesn’t want to pay.

Puerto Rico, by contrast, is stuck in the worst of all worlds. It has to abide by the rulings of New York courts, should bondholders file suit. And at the same time, it’s not allowed to file for — and receive the protections of — bankruptcy. (US municipalities, like Detroit, can file under Chapter 9 of the American bankruptcy code; Puerto Rico, which is a territory, cannot.) As a result, Puerto Rico is at the mercy of the courts, which will take one look at the island’s unambiguous bond contracts and declare that it has to pay its debts, in full.

When Puerto Rico says that it wants to negotiate with its creditors, then, it’s in a very, very weak negotiating position: the rational response for the creditors to take is, essentially, “fuck you, pay me”. Puerto Rico’s bondholders have first dibs on nearly all of the territory’s tax and utility revenues, and if they exercise that right, that leaves almost nothing left for desperately-needed investment.

Adding insult to all of this injury is the list of “reforms” that the former IMF staffers consider the bare minimum to get Puerto Rico up and running again — what they call “a strategy for growth and confidence”. Most of them, for starters, are entirely outside Puerto Rico’s control. The Puerto Rico government can’t unilaterally suspend the Jones Act, for instance: only the US government can do that. And neither can the Puerto Rico government change American law to allow the territory to file for Chapter 9 bankruptcy. But unless and until that happens, there’s almost no hope for the island, which will never be able to get out from under its enormous debt burden.

Even a clean bankruptcy proceeding, however, wouldn’t be enough to get Puerto Rico back onto a growth path. The former IMF staffers’ report also patiently explains that the minimum wage on the island (the US’s federal minimum wage) is a clear obstacle to growth: it’s much higher than prevailing wages elsewhere in the Caribbean, and creates what they call “disincentives for firms to hire workers”. As a result, their first proposal is to abolish the minimum wage entirely; failing that, they say, “an alternative might be to set the rate for Puerto Rico at one-third the general rate”. I’ll do the math for you: that works out at a minimum wage of just $2.41 per hour.

If you can’t live on $2.41 an hour, can you at least rely on welfare? No: the IMF staffers explicitly want welfare payments in Puerto Rico cut, on the grounds that they are “are a disincentive for the unskilled to accept work”.

How about the creditors? How much of the burden would they share, under this vision? Actually, none: the idea would be that Puerto Rico’s bonds would be reprofiled in such a manner that “the reform program will increase the expected value of their claims”. Whatever the value of Puerto Rico’s bonds is now, in other words, the island’s government is going to have to come up with a plan to make that value go up, rather than down.

Remember: this is the best case scenario for Puerto Rico — one where the federal government steps in to allow the territory to enter bankruptcy protection, and where a broad-based default doesn’t cause the entire economy to simply implode. A much worse outcome is easy to envision — one where almost every employable Puerto Rican decides to decamp for much better prospects in states like Florida or New York, and the island essentially ceases to exist as an economically viable entity.

All of which is to say that a debt default, even when it’s necessary and unavoidable, is always extremely painful. Life in Puerto Rico is bad now, but with this week’s announcement we can be sure that it’s going to get worse. So next time you see headlines about the suffering that’s being inflicted on Greece, remember that the US is doing something very similar, to its own citizens, in Puerto Rico.