After years of financing its operating deficits with debt, the U.S. territory of Puerto Rico is in dire fiscal trouble, and faces the possibility of defaulting on its general obligation bonds, which are heavily traded on U.S. markets, and are largely owned by U.S.-based municipal bond funds. Those obligations total about $73 billion, which gives the Puerto Rican people a higher per capita debt load than any of the 50 U.S. states at a time when a struggling economy is pinching government revenues.
The government of the island territory is running out of cash, and is trying to arrange a $2.9 billion bond sale to allow it to meet those bond payments and other obligations. However, the government’s already-low credit rating was dropped even deeper into junk bond status this week by Standard & Poor’s. The ratings agency now classifies Puerto Rico’s debt at CCC+ which means that “In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.”
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The ratings cut extended to a number of the island’s government agencies, including bonds issued by the Puerto Rico Sales Tax Financing Corp., the Puerto Rico Municipal Finance Agency, the Puerto Rico Employees Retirement System, and the Highway and Transportation Authority.
That means that investors in Puerto Rican bonds are going to demand a much higher return in order to take on the additional risk of default, which makes it more expensive for the government to borrow, further adding to its fiscal problems.
The country’s Government Development Bank last week said that the government will likely run out of money within 90 days unless drastic steps are taken to raise revenue.
One potential step is currently being battled over in the legislature. Governor Alejandro Garcia Padilla has called for the imposition of a 16 percent value added tax (VAT) that would restore needed cash flow to the government. However, the introduction of such a large tax is facing serious political hurdles, as well as doubts about whether the move will have the desired effect. For example, it’s not clear that a new tax could be implemented quickly enough to generate the revenue the island desperately needs.
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Explaining their downgrade of Puerto Rico, S&P analysts wrote, “It is our opinion that even if the proposed value-added tax (VAT) were enacted by the legislature without delay, without external financing, liquidity may still fall below thresholds necessary to maintain operations and fund financial commitments.”
What’s more, they said, it might do more harm than good. “We also believe budget pressures are exacerbated by current weak economic trends and high debt levels, factors likely to persist in the long term. Imposition of a large VAT may increase overall tax revenue, but have negative short-term economic implications.”
Representatives of the U.S. Treasury Department have been in near constant talks with Puerto Rican officials in recent weeks. However, the Obama administration has been adamant that a financial bailout package for the island is not in the offing.
One problem unique to Puerto Rico is that it doesn’t enjoy the same protections under bankruptcy law as actual U.S. states. Under Chapter 9 of the bankruptcy code, states and municipalities can seek relief in bankruptcy court, and restructure their debts into a more manageable burden.
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However, Chapter 9 does not apply to Puerto Rico.
There has been a half-hearted effort to change that in Congress. Puerto Rico’s representative in Congress, Resident Commissioner Pedro Pierluisi, has introduced the Puerto Rico Chapter 9 Uniformity Act in the House of Representatives. The bill would treat the territory as a state for purposes of Chapter 9 of the Bankruptcy code. The bill, however, has no co-sponsors, and is currently languishing in the House Judiciary Committee, which has not acted on it.
Former Governor of Puerto Rico Luis G. Fortuño recently wrote in The Hill, “From a bankruptcy policy perspective, I do not believe that the current exclusion ever made sense; it certainly doesn’t make any sense now. Puerto Rican bonds are heavily traded in the U.S. municipal bond market, so the legal rules should be the same in Puerto Rico as they are in the 50 states.”
The bill, he said, “offers Puerto Rico a road to recovery that will both honor its obligations to American investors and lead to safe investment and economic growth in years to come. Without the right for troubled government entities to restructure obligations, collective debt may overwhelm Puerto Rico as a whole, and a federal bailout will be required.”
The bill, however, appears to have no momentum in Congress, meaning that in the near term, at least, a major tax hike seems to be the only move available to the government. Puerto Rican media outlets on Tuesday were reporting that the bill could be voted out of committee in the legislature as soon as today, but wrangling over the level of the tax and the future possibility of reducing it have, so far, stood in the way of an agreement.
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