Financial crisis that began affecting Puerto Rico in 2014
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The Puerto Rican government-debt crisis was a
several bond issues by Puerto Rico to "junk status" after the government was unable to demonstrate that it could pay its debt. The downgrading, in turn, prevented the government from selling more bonds in the open market. Unable to obtain the funding to cover its budget imbalance, the government began using its savings to pay its debt while warning that those savings would eventually be exhausted. To prevent such a scenario, the United States Congress enacted a law known as PROMESA, which appointed an oversight board with ultimate control over the Commonwealth's budget. As the PROMESA board began to exert that control, the Puerto Rican government sought to increase revenues and reduce its expenses by increasing taxes while curtailing public services and reducing government pensions. These measures provoked social distrust and unrest, further compounding the crisis. In August 2018, a debt investigation report of the Financial Oversight and management board for Puerto Rico reported the Commonwealth had $74 billion in bond debt and $49 billion in unfunded pension liabilities as of May 2017.[2] Puerto Rico officially exited bankruptcy on March 15, 2022.[3][4]
Background
Distribution of Puerto Rico's outstanding debt as of October 18, 2013[5]
Government-owned corporations (37%)
GO bonds (29%)
COFINA (22%)
Other (3%)
Retirement systems (4%)
Municipalities (6%)
Puerto Rico's budget expenses in relation to its debt obligations. Almost 9.6%—or about $1.5 billion—of Puerto Rico's central government budget expenses for FY2014 was expected to be spent on debt service.[5]
Operational expenses (90.4%)
Debt service appropriations (6.9%)
Debt service on interests (1.7%)
Debt issued to cover deficit (1.0%)
Puerto Rico is a
Territorial Clause
of the federal constitution. It has had an elected governor since 1948, and elected legislature since 1900.
The federal
to fund its expenses, a practice repeated for four decades since 1973.[8] The island also began to issue debt to repay older debt, as well as refinancing older debt possessing low-interest rates with debt possessing higher interest rates.[9]
In 1984, Congress explicitly forbade Puerto Rico from declaring bankruptcy under
In 1917, the United States Congress authorized the government of Puerto Rico to issue triple tax-exempt municipal bonds. These bonds were highly attractive to U.S. investors and very low cost for Puerto Rican local government to issue, laying the groundwork for the ballooning national debt, and a public infrastructure built on that debt.[15] A constitutional amendment in 1952 relaxed balanced budget requirements for Puerto Rico in comparison to the states and another in 1961 loosened the reins on debt capacity, encouraging Puerto Rico to continue to fund fiscal shortfalls through the issuance of triple-exempt municipal bonds.[15]
Cessation of federal subsidies
For much of the 20th century, Puerto Rico was subject to favorable tax laws from the US federal government, which essentially acted to subsidize the island's economy. In 1996, US President Bill Clinton signed legislation phasing out important parts of the favorable federal tax code over ten years ending in 2006.[16][17] The end of the subsidies led to companies fleeing the island which itself subsequently led to tax shortfalls. At first, the Puerto Rican government tried to make up for the shortfall by issuing bonds. The government was able to issue an unusually large number of bonds, due to dubious underwriting from financial institutions such as Santander Bank, UBS, Barclays, Morgan Stanley, and Citigroup.[18][19][20][21] Eventually, the debt burden became so great that the island was unable to pay interest on the bonds it had issued.
Mismanagement and disparity
Some newspapers, such as
comprehensive annual financial reports late, sometimes 15 months after a fiscal year ends, and the government as a whole constantly fails to comply with its continuing disclosure obligations on a timely basis.[26][m] The government's accounting, payroll, and fiscal oversight information systems and processes also have deficiencies that significantly affect its ability to forecast expenditures.[n]
Similarly, salaries for government employees tend to be quite disparate when compared to the private sector and other positions within the government itself. For example, a public teacher's base salary starts at $24,000, but that of a legislative advisor starts at $74,000.
The government has also been unable to set up a system based on
per diems and expense money.[29] Just like the central government, municipalities would issue debt through the Puerto Rico Municipal Financing Agency to stabilize their finances, rather than make adjustments. In total, the combined debt carried by the municipalities of Puerto Rico accounts for $3.8 billion, or about 5.5% of Puerto Rico's outstanding debt.[q][r]
During the New Deal, an appointed Governor, Rexford Tugwell, created the Puerto Rico Electric Power Authority (PREPA) by nationalizing the island's private utilities.[12] The state monopoly provides free electricity to local governments, which prompted the mayor of Aguadilla, Puerto Rico, to build an ice-skating rink.[12] PREPA uses oil-fired power plants, has had opaque purchasing practices, has resisted wind and solar power projects, and has a debt of $9 billion.[12] PREPA has had poor bill collection practices, with FTI Consulting estimating that the utility had improperly given away $420 million of electricity and that the island's governments were $300 million delinquent in payments.[12] In 2012, the Puerto Rico Ports Authority was forced to sell the Luis Muñoz Marín International Airport to private buyers after PREPA threatened to cut off power over unpaid bills.[12] In 2014, the Puerto Rico Energy Commission was established.[12] After the neglected power grid was destroyed by Hurricanes Irma and Maria, PREPA was privatized from 2018 to 2021.
Economic depression
Between 2007 and 2017 Puerto Rico's gross national income declined by 14 percent, and in 2015, 46 percent of the population lived below the federal poverty line, compared to the U.S. national average of 15 percent.[15] Puerto Rican national debt is now approximately $74 billion, but unlike mainland municipalities, Puerto Rico is not protected by Chapter 9 of the U.S. Bankruptcy Code and cannot file for bankruptcy.[15]
Tax policy
A federal statute that contributed to the crisis was the expiration of Section 936 of the Internal Revenue Code, which had applied to Puerto Rico.[s] The section was critical for the economy of the island, as it established tax exemptions for US corporations that settled in Puerto Rico and allowed its subsidiaries operating in the island to send their earnings to the parent corporation at any time without paying federal tax on corporate income. The economy of the island was significantly reliant on the additional investment and spending generated by companies taking advantage of that provision and has been unable to replace the benefit after its loss.[s]
Disparity in federal social funding
More than 60% of Puerto Rico's population receives
Mississippi, a state with a population similar to that of Puerto Rico, receives $3.6 billion.[33] The situation leads to an exodus of underpaid health care workers to the mainland, and the disparity has also had a major impact on Puerto Rico's finances.[33]
Triple tax exemption
Interest income paid to owners of Puerto Rican government-issued bonds is exempt from federal, state, and local taxes, the so-called "triple tax exemption."[c] Such bonds retain their tax exemption regardless of where the bondholder resides in the United States,[b][c][d] unlike most other US triple tax-exempt bonds in which exemptions are available only to bondholders that reside within the state or municipality that issues the bonds. Triple tax-exempt bonds are considered to be subsidized because bond issuers can offer a lower interest rate to satisfy bondholders and so Puerto Rico is able to issue more debt.
2014 downgrade
Multiple bond-rating agencies downgraded Puerto Rico's debt to non-investment grade in early 2014. On February 4,
Moody's downgraded Puerto Rico's GO debt from Baa3 to Ba2, two levels below investment grade.[36] Moody's, however, cited lack of economic growth for its downgrade while assigning a negative outlook to the government's ratings. Fitch Ratings would be the last to downgrade on February 11, 2014, by downgrading Puerto Rico's GO debt from BBB− to BB, two levels below investment grade.[13] Fitch cited both liquidity concerns and lack of economic growth for its downgrade while assigning a negative outlook to the government's ratings. These downgrades triggered several acceleration clauses, forcing Puerto Rico to repay certain debt instruments within months rather than years.[f]
2015 forbearance
On June 28, 2015, Governor García Padilla admitted publicly that "the debt is not payable" and that if the government was unable to grow the economy, "we will be in a death spiral.[t][u] Before Padilla's admission, various government instruments had already entered into forbearance agreements with their lenders, but the warning still provoked a drop in Puerto Rican bonds and stocks.[38][39]
Reactions
Local market
Around $30 billion, or about 42% of Puerto Rico's outstanding debt, is owned by residents of Puerto Rico. They and local businesses are the parties that are most affected by the government cuts and the increased taxes that have been imposed to stabilize the island's finances. Michele Caruso from CNBC reported on January 24, 2014, "Taxes and fees went up on nearly everything and everyone. Personal income taxes, corporate taxes, sales taxes, sin taxes, and taxes on insurance premiums were hiked or newly imposed. Retirement age for teachers was raised from as low as 47 to at least 55 for current teachers, and 62 for new teachers."[1] That is a significant cost to bear for a country with a purchasing power parity (PPP) per capita of $16,300 and with 41% of its population living below the poverty line.[v] The legislative assembly, together with the governor, also reduced operating deficits, and reformed the public employees', teachers', and judicial pension systems.[w] They also announced the intent to further reduce appropriations in the current fiscal year by $170 million and budget for balanced operations for the upcoming fiscal year.[x] As another countermeasure, the 17th Legislative Assembly of Puerto Rico enacted a bill on March 3, 2014, allowing the Puerto Rico Government Development Bank to issue $3.5 billion in bonds to recover its liquidity. The Governor promptly signed the bill the day after, effectively becoming law as Act 34 of 2014 (Pub.L. 2014–34).[41][42]
US municipal market
Nearly 70% of US-based municipal bond funds own Puerto Rican bonds or have some kind of exposure to Puerto Rico.[y] A notable cause for this tendency is the fact that Puerto Rican bonds are triple tax-exempt in all of the states regardless of where the bond holder resides.[c] Despite the expected impact, pre-emptive measures slowed the damage of the downgrade's fallout.[43] When the downgrade began to be perceived as imminent, investors were warned that it would affect the municipal market in general, and concerns of a worst-case default scenario were already being considered.[44] However, by the end of February 2014, municipal bond funds that relied on specific debt had already experienced the backlash, which left portfolio managers with fewer options in the market.[45] Organizations such as First Investors made it clear that they did not intend to invest in Puerto Rico for a prolonged period, at least until Puerto Rican bonds were restored to investment grade.[45]
Skepticism
Several
Jenniffer González, claim the crisis is mere propaganda, created so the incumbent political party could enact, amend, and repeal laws that it would otherwise be unable to justify.[z][aa] Others, such as the President of the Senate of Puerto Rico, Eduardo Bhatia, claim the crisis was created by ruthless investors, who wish to profit from credit downgrades.[48]