November 6, 2013

ALAS FOR Puerto Rico, the Caribbean commonwealth attracts little attention on the U.S. mainland except when it’s in trouble. So it is with the looming crisis over Puerto Rican public debt, estimated at $70 billion. Detroit’s bankruptcy was bad for the municipal bond market; a default by Puerto Rico, though unlikely, could be worse: Some 70 percent of U.S. municipal-bond mutual funds hold the island’s paper, which bears tax-free interest. Large U.S. bond insurers are heavily exposed as well.

How Puerto Rico got into this mess is a long story, with plenty of villains: The island’s government frittered away funds on unproductive investments and bloated payrolls; Wall Street bankers enabled more borrowing, collecting $880 million in fees since 2000; the U.S. government's policy of tax-free status for Puerto Rico bonds, meant to boost its economic development, subsidized the island’s habit of living beyond its means.

And last but not least is the near-collapse of economic growth.Puerto Rico’s output has declined 16 percent since 2004. Its recession, triggered by the 2006 phaseout of a federal manufacturing tax break, began before that of the mainland and lasted longer. Only about a million of Puerto Rico’s 3.6 million people are employed. Not coincidentally, Puerto Rico’s population shrank 4 percent in the past decade, as many of the best and brightest sought opportunity on the U.S. mainland.

Newly elected Gov. Alejandro García Padilla has raised the retirement age and pension contributions for public employees and broadened the sales-tax base; his government’s current budget calls for $750 million in borrowing, the smallest amount since at least 2009. Even assuming it meets that target, Puerto Rico would still be spending too much on short-term needs such as interest payments and the public-sector payroll as opposed to productivity-enhancing investments.

Commonwealth officials say default is not only undesirable but, literally, unconstitutional since Puerto Rico’s constitution gives general-obligation bondholders first dibs on the island’s cash. But that guarantee has never been tested in a predicament such as this, which is economically analogous to Detroit’s — and that of Greece, another heavily indebted political entity linked in a currency union with far larger and more competitive neighbors.

Yet unlike Detroit, Puerto Rico is not a city, so it cannot pursue bankruptcy under Chapter 9 of the federal code. Unlike Greece, it lacks the sovereign power to negotiate a bailout with the International Monetary Fund. In theory, Congress might offer conditional aid, backed by a financial control board such as the one imposed on the District in the 1990s. But Congress is hostile to bailouts, the Puerto Ricans are not asking for one — yet — and it’s not clear how such a solution would fit within the unique legal and constitutional framework that links the United States and Puerto Rico.

In short, Puerto Rico’s economic and financial woes are structural — traceable, ultimately, to its muddled political status, still not fully resolved despite decades of tedious political wrangling. But there will be time enough to debate that later. For now, and probably for years to come, the more mundane problem of ensuring solvency will have to take priority.