Puerto Rico Bankruptcy

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Several months ago I posted a warning that Puerto Rico was about to become our version of Greece. Its profligate policies and misguided tax manipulations by the federal government have created a financial disaster. Basically, Puerto Rico is a third-world economy attempting to live like a U.S. state, very much like Greece’s position in the E.U. Just like Greece, Puerto Rico is in a monetary union with the rest of our states but without a common fiscal policy. Now the predictable consequences have come to pass. Within weeks, Puerto Rico will default on its bills and will be unable to provide municipal services. Before long, chaos will ensue unless something is done promptly in Congress. What chance do you think that has of happening?

There is so much wrong that no simple solutions will work, and some possibilities are precluded by their commonwealth status. Under current law, their municipalities and public corporations cannot file for Chapter 9 bankruptcy, an option allowed in any of our 50 states. Changing this requires Congressional action, and without this option a disorderly disintegration of public services will eventually occur. But by the best accounting, even that change probably is insufficient as the commonwealth’s public debt is unserviceable. Default will freeze investment, with unknowable consequences.

Belatedly, the Obama administration has gone before Congress to present a solution and it is breathtaking in its concept. Recognizing that only a major action might work, the plan proposes to allow Puerto Rico itself to declare bankruptcy. No U.S. state can do this. In fact some scholars argue that the Constitution wouldn’t even allow that for states, which retain residual sovereignty. Nevertheless, allowing Puerto Rico to declare bankruptcy would no doubt impair every state’s fiscal rating, as the suspicion would linger that some might grasp this lifeline in extremis.

The White House has stated that this resolution would be restricted to U.S. territories, so that Guam for example could go bankrupt but not Mississippi or California. However this is just a statement of policy, not law, and suspicious buyers would likely demand higher interest on all state bonds. This administration approach will be very costly, as federal funds in the billions would be needed and the indirect cost from higher interest rates would add immeasurably.

There is a side effect of this resolution that isn’t insignificant. The status of Puerto Rico is odd. Its residents are citizens of the U.S. but they have only non-voting representation in Congress. They have had plebiscites offering the alternatives of independence or application for statehood, but so far neither has achieved the necessary support. In fact, it is not obvious that statehood would be granted. What benefit do we accrue from adding them as our 51st state? But in any case, if this bankruptcy idea were actually employed, that would probably preclude statehood for the foreseeable future. As a result we would have this dependent child to support for decades to come.

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