Puerto Rico has the population of Connecticut and an economy smaller than Nebraska s. It also has more debt $74 billion than any U.S. state government except California, New York and Massachusetts. The debt, a result of financial mismanagement, Wall Street complicity and good intentions gone awry, will limit the territory s ability to rebuild after being destroyed by a hurricane. New questions as to whether the hobbled island will be able to repay weigh on investors far beyond the Caribbean island.
Puerto Rico was already struggling with its debt load when Hurricane Maria hit on Sept. 20. After President Donald Trump toured damaged sites on the island Oct. 3, he said of the debt we re going to have to wipe that out, though his budget director said this shouldn t be taken literally. The federal oversight board created by the U.S. Congress in 2016 to manage Puerto Rico s finances has asked Congress for maximum federal assistance to help repair what could be $95 billion in damages. This, the board noted, is roughly 150 percent of the island s annual gross national product. The board had previously filed a bankruptcy-like case in May 2017 to slash the island s debt. This restructuring, the biggest ever by a U.S. state or local government, followed Puerto Rico s failure to craft a restructuring deal with its creditors. Washington took action after Puerto Rico stated in 2015 that it was unable to pay its borrowings and the defaults began to pile up. Unlike the bonds of most states and municipalities, Puerto Rico s are exempt from local, state and federal taxes everywhere in the U.S., making the debt attractive to mutual funds. As a result, they were once held by about half of open-end muni funds. (They re now mostly held by hedge funds and big investment firms betting they ll rebound.) The competitive advantage made it easy for Puerto Rico to double its debt in 10 years by selling bonds to plug annual budget deficits and pay for operating expenses the same combination that brought New York City to the brink of bankruptcy in the 1970s.
Wall Street smoothed the island s path to fiscal debacle, reaping more than $900 million in fees to manage Puerto Rico s $126.6 billion of bond sales since 2000. After the U.S. territory adopted a sales tax in 2006, investment banks worked with officials in San Juan to create new bonds backed by a portion of the proceeds. These helped the government, which employs more than a quarter of the workforce, put off cuts. Puerto Rico, ceded to the U.S. in 1898 after a war with Spain, has a special tax status that dates to 1917 and the passage by the U.S. Congress of the Jones-Shafroth Act. It has relied on tax breaks to drive economic development, attracting pharmaceutical, textile and electronics companies. The U.S. phased out the incentives from the mid-1990s to 2006, contributing to the loss of 80,000 jobs. Since 2006, the island s economy has contracted every year except one and its poverty rate is double that of Mississippi, the poorest state.
The population of 3.4 million was shrinking before Maria struck; 400,000 have left since 2008. With so many businesses destroyed, more people are likely to head to the mainland in search of jobs, leaving fewer people behind to pay taxes. It may take months to restore power. The island s government-owned power authority, Prepa, owes more than $8 billion and was already operating under court protection from creditors. Since it could cost billions just to rebuild the power grid, bondholders fear they may have to wait even longer to get repaid. The financial control board, set up by a Congress firmly against anything that smacked of a federal bailout for Puerto Rico, was supposed to help the island make the politically unpalatable decisions needed to repair its public finances, like closing schools and cracking down on tax evasion. The board has now authorized $1 billion to go to emergency relief and will be under pressure to divert more money slated for debt payments. Critics of the control board say that the disaster could provide cover for it to expand its mission into restoring broader economic health. Others say that Congress could help Puerto Rico s economy by permanently repealing the 1920 Jones Act, which President Donald Trump waived temporarily on Sept. 28. The law, which mandates that goods transported between U.S. ports use U.S.-built ships staffed with American crews, makes shipping between the U.S. and Puerto Rico sometimes twice as expensive as shipping to nearby islands.
Martin Z. Braun and Tatiana Darie contributed to earlier versions of this article.
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First published Feb. 11, 2014
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Michelle Kaske in New York at [email protected]
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