THERE WAS long-overdue drama at a Capitol Hill hearing Thursday. We are referring, of course, to Treasury Department counselor Antonio Weiss’s testimony before the Senate Committee on Energy and Natural Resources, in which he warned of a looming “humanitarian crisis” in the financially distressed commonwealth of Puerto Rico. Mr. Weiss’s words marked a break with the Obama administration’s previous low-key approach to the island’s debt crisis, and if he resorted to hyperbole to compensate for that, it was only slightly. Having already cut spending, jacked up taxes and postponed various bill payments, Puerto Rico is out of cash and facing a year-end liquidity crunch that could lead to a breakdown in public services, or even public order.
Mr. Weiss backed up his words with the administration’s most comprehensive policy proposals yet, the most important of which would require congressional action. Specifically, he advocated not only permitting Puerto Rico’s municipalities and public corporations to file for bankruptcy, which would affect about a third of its $73 billion debt, but also extending the bankruptcy option to the commonwealth government itself. He called for a permanent fix to the island’s Medicaid program, which faces crippling uncertainty because of limits on federal assistance unlike those of the 50 states. And to address its lagging labor force participation – a huge drag on economic growth – he proposed creating an Earned Income Tax Credit to encourage low-wage workers’ return to the job market.
In short, for the first time the executive branch has put its weight behind solutions that would cost money, billions of dollars of it. A good benchmark would be Gov. Alejandro Garcia-Padilla’s projection of a $14 billion hole in the island’s finances over the next five years. The administration’s plans for Medicaid and an EITC would put U.S. taxpayers on the hook. Bankruptcy would be the mechanism through which creditors chip in; an average 40 percent “haircut” on their bonds is probably in order, according to a recent study by BlackRock. As the example of Detroit shows, letting an impartial bankruptcy judge sort out the competing claims on a failed public entity is the fairest, most efficient approach; without that option, Puerto Rico has no leverage in debt negotiations, and litigation could ensue.
Which brings us to what can fairly be expected of the commonwealth itself. Its predicament is due to many forces beyond its control, starting with the anomalous semi-sovereign political status that traps it – like Greece in the European Union — in a monetary union with the far larger and more competitive United States. Still, Puerto Rico has squandered vast resources on mismanagement and anti-growth policies. Therefore, it may appropriately be held to a structural adjustment program that ensures it uses fresh cash efficiently. For that program, in turn, to have credibility, it must be subject to oversight by a truly independent body; indeed, if oversight doesn’t work, nothing in Mr. Weiss’s plan can work, either economically or politically, since buy-in from Republican fiscal hawks is needed. Designing that institution is the task to which Congress, Puerto Rico and the administration must now turn in a spirit of cooperation, but also urgency.