— Attempts to resolve the immediate crisis by allowing Puerto Rico to restructure its debt have been languishing in Congress; House Speaker Paul D. Ryan (R-Wis.) introduced draft legislation in March, but it hasn’t gone anywhere.
— Restructuring has no costs for taxpayers. The burden falls on creditors, who will be paid less than the face value of the bonds they hold.
— However, without a restructuring, a taxpayer-funded bailout is surely forthcoming.
Okay, that last one is a prediction, not a fact, but I’m very likely to be right about it. And that would be a transference to taxpayers of the costs of cleaning up this mess from creditors, including hedge funds that bought Puerto Rican debt at a steep discount a couple of years ago.
Let me explain (better yet, see John Oliver’s masterful explanation below). For years, the Puerto Rican economy has underperformed. Today, poverty and unemployment on the island are about 46 percent and 12 percent, respectively, and the population is shrinking as people jump ship for the mainland. That has done long-term damage to revenue collection, and the government over-borrowed to make up the difference.
The government is far from blameless, but the costs of the crisis are, as usual, falling on the people with the least means to avoid the pain, people who are American citizens. When such obviously unsustainable borrowing has occurred in other places that can’t dig their way out of their debt hole, such as Detroit or Stockton, Calif., they have declared bankruptcy and restructured their debt. That means a bankruptcy judge enforces “haircuts” on creditors who end up with less than they were originally owed. In Detroit, for example, creditors got an average of about 60 cents on the dollar.
The problem is that Puerto Rico, as a commonwealth, does not have that option. That is why it will take legislation to allow a restructuring of the island’s debt. The bill before Congress “would create a federal oversight board with the power to approve or reject local budgets, and to approve plans for court-supervised debt restructuring.”
Now, here’s my punch line, telegraphed above, and it’s very simple: If we don’t do the restructuring, we will end up with a taxpayer-funded bailout. I don’t know how large it would be, but I see no other possible outcome.
You may wonder: Why should the creditors get dinged and the taxpayers spared? Fair question, but the fact is that insolvency happens, and any IOU (i.e., bond) you purchase has default risk. In fact, such risk is priced in, with riskier debt paying higher yields, and, in the case of Puerto Rico, sold at a discount to hedge funds and other creditors (including pension funds) that think their hair looks fine, thank you.
Bottom line, I don’t think it’s a stretch to recognize that purchasing Puerto Rican debt was a risky move. Although defaults are rare in the muni market — only 0.14 percent of munis default within 10 years — the Puerto Rican economy cannot generate anything like the growth needed to service its debt. Creditors’ bets went bad, and the senseless quirk in the law that has no Chapter 9 mechanism for the commonwealth is the only reason we’re even arguing about them.
Why is a bailout the only alternative? Because I don’t think the nation will let fellow Americans suffer the consequences of living in a failed state as the human costs become increasingly severe. Yes, we are in a moment of considerable political upheaval, but this conclusion is bipartisan: The Obama administration strongly supports the restructuring bill, and Ryan has been doing his best to advance the legislation. Even Donald Trump recognizes the insolvency.
With the muni market at least so far brushing off the Puerto Rican default, and the broader economic costs of muddling through not obvious to most of us on the mainland, the crisis could easily drag on. That’s not a problem for many in the investor class. Remember, hedge funds invested in defaulted Argentinian debt fought 15 years before achieving a payout greater than 10 times their investment.
But it’s a huge problem for our fellow citizens in Puerto Rico, and it’s soon going to be a big problem for taxpayers. That last part can easily be avoided if Congress gets its act together.