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Puerto Rico Debt Crisis Could Lead to Catastrophe

Administration officials are warning of a humanitarian crisis if Congress does not move to address Puerto Rico’s debt crisis.

The island territory is not only unable to make debt service payments on about $70 billion in debt, but is struggling to fund public safety, health and education, according to Antonio Weiss, counselor to Treasury Secretary Jacob Lew. The worry is that the lack of money could have catastrophic consequences for Puerto Ricans.

“Puerto Rico is already in distress, what started as a recession has turned into a fiscal and a liquidity crisis that shows signs of becoming a humanitarian one as well,” Weiss told a House panel last week.

While House Speaker Paul D. Ryan has given the House until March 31 to address Puerto Rico’s crisis, some Republicans on Capitol Hill are questioning the Obama administration’s proposal to allow the island’s government to, in effect, declare bankruptcy.

Rep. Tom McClintock, R-Calif., said that allowing Puerto Rico to walk away from a portion of its debt through a bankruptcy-like process would undermine the sovereign debt of the other 50 states.

“I’m afraid that credit markets are going to say, ‘Well, wait a second. If they can do that to the Puerto Rican debt, they can do that for California and Illinois and New York,’” McClintock said.

A number of governors have suggested that investors will demand that states pay higher interest rates if Puerto Rico’s debt is restructured, he noted.

Weiss, though, said that proposed legislation would cover U.S. territories, of which Puerto Rico is one, and not states. The administration has talked to bond investors about the plan and they understand this. Those investors have said that any move to curb Puerto Rico’s crisis – and its continuing and projected defaults on bond payments – would help calm the fears of investors who put money into state bonds, he says.

It’s easy to understand the concerns about the island’s trajectory from a few numbers. Puerto Rico’s unemployment rate is still 12.2 percent, almost double the rate of 6.8 percent in Mississippi, the state with the highest rate, according to data from the Bureau of Labor Statistics.

Puerto Rico’s unemployment rate has dropped from more than 16 percent to its current level, but not because businesses are creating jobs there. Driving the decline in the unemployment rate is the island’s unprecedented depopulation.

Between 2010 and 2015, the U.S. population increased 4 percent, or 12.7 million people. Nearly 60 percent of the increase came from births outnumbering deaths, with the rest coming from immigration.

Over the same period, Puerto Rico lost 7 percent of its population. Births outnumbered deaths by 44,000, but one out of every 13 people left the island, a total of 296,000 who emigrated. If they had not left the island, causing the labor force to shrink, and if businesses had created the same number of jobs, the island’s unemployment rate would have ballooned to 29 percent.

The island’s government has been criticized for both mismanagement and for keeping inadequate data about its problems. But economists agree that most of the debt is owed to individuals, many of whom are pensioners. One estimate puts some 80 percent of bondholders into this category, with one-fifth of those being residents on the island, said Juan Carlos Batlle, senior managing director of CPG Island Servicing.

Batlle and other experts gave their views on the island’s fiscal problems and possible solutions at a House Financial Services subcommittee hearing last week.

“We all agree that we should do the right thing,” said Rep. Al Green, D-Texas, who urged that the island be allowed access to Chapter 9 protection under the U.S. Bankruptcy Code.

Not all of Puerto Rico’s debt could come under that protection, though, but what many are calling a Super Chapter 9 option from the Obama administration would apparently cover all of the debt. The administration has also proposed additional Medicaid funding for Puerto Rico and the extension of the Earned Income Tax Credit to its residents.

Allowing Puerto Rico to seek bankruptcy protection for all of its debt would “most certainly raise the cost of borrowing for the 50 states,” said William M. Isaac, senior managing director of FTI Consulting and a former chairman of the Federal Deposit Insurance Corporation.

Isaac suggested putting just a portion of Puerto Rico’s debt into Chapter 9, while creating a federal control board that would oversee the rest of the debt.

“Everything I’ve heard today smacks of being a bailout, which my party is supposed to be against,” said Mick Mulvaney, R-S.C. Mulvaney also objected to the idea that Puerto Rico’s individual bondholders be paid ahead of other creditors.

Most of the creditors on the $70 billion in debt are pensioners, both in Puerto Rico and in the 50 states, he said, noting that he would oppose putting the island’s pensioners ahead of other American pensioners.

But Rep. Sean Duffy, R-Wis., who has introduced legislation to allow Puerto Rico to declare bankruptcy for a portion but not all of its debt, said that there is a difference between bankruptcy and bailout. In one, taxpayer money is used, and in the other, it isn’t, he said.

Duffy noted that concerns about the impact on other states, though, needs to be addressed in whatever solution is chosen.

“We owe it to all parties to ensure that our response does not have negative implications to the rest of the bond market,” he said.

The Obama administration proposed in early February a lifeline for the territory that would allow it to restructure its debts under federal supervision – but stopped short of offering formal bankruptcy protection under Chapter 9. Puerto Rico is currently ineligible to seek Chapter 9 protection. Congressional Republicans oppose giving it that right.

In testimony before the House Natural Resources Committee, Weiss said the administration opposes Chapter 9.

“We’re not proposing Chapter 9 or any new chapter of the code,” Weiss said. “We’re proposing a territorial act which would allow for restructuring authorities only by acting through and with an oversight board.” He later stressed that the administration’s proposal would be “a legislative act that is tailored to the territories.”

Mark Zandi, chief economist at Moody’s Analytics, suggested restructuring the debt would “allow for a timeout” in the struggle between Puerto Rico and the 20 different creditor groups holding bonds issued by a variety of Puerto Rican government entities. Also, the Medicaid situation on the island must be addressed, since funding for that program is going to decline by the middle of 2017 and half of Puerto Ricans use Medicaid, he noted.

The island has payments of about $472 million due to creditors between now and April 1, and has already partially defaulted twice on debt payments in the last six months, according to the subcommittee. Interest payment on the debt accounted for 40 percent of government revenue last year, compared with 5 percent in the average state.

The island’s fiscal situation is “very dark,” Zandi said. For the Puerto Rican economy, the Great Recession never ended. The economy “slid sharply during the financial crisis of 2008-9, and has continued to slump ever since,” said Zandi. Puerto Rico’s economy is “far and away the weakest of any state in the country,” he said.

“Those that are leaving are more highly skilled and educated,” he said. “Only 24 percent of Puerto Ricans have earned at least a college degree, compared with more than 30 percent nationally.”

Jonathan Miller contributed to this report.

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