ISSUES

PUERTO RICO – A U.S. AREA


Puerto Rico has been a U.S. territory since 1898, and, as such, the Government of the United States has been responsible for the welfare of its people under the U.S. Constitution.

Puerto Ricans have been granted U.S. citizenship – and have served in the U.S. military — since 1917. The Commonwealth of Puerto Rico – the insular government – has been allowed to exercise the authority of a State on local matters but does not have voting representation in our national government. It and its 3.5 million people are only represented in the U.S. House of Representatives by a sole resident commissioner who can only vote in House committees.

The territory is treated like a State under most – but not all – Federal laws. Its worse than equal treatment or exclusion from a number of major Federal programs is largely responsible for its economic underdevelopment. The insular government must pay for much of what the Federal government pays for in the States and the District of Columbia.

The islands experienced phenomenal economic growth in the 1950s and ‘60s but its economy has lagged that of the States since the 1970s, largely because of changes in national and international economic policies. It has been in recession for eight of the last nine years, losing 23% of its jobs. The unemployment rate is more than double the national rate with less than two-thirds the percentage of people still in the labor market than in the States. Thirty percent of people born in Puerto Rico alive today have moved to a State for greater opportunities. The relocation rate has grown to about 1,000 per week. Puerto Rico’s population is now decreasing for the first time in its history

Puerto Rican bonds were authorized by both the federal and commonwealth governments. Because of this, interest from the bonds cannot be taxed by and government anywhere in the Nation, according to federal law.

All three national government credit rating agencies have downgraded bonds of Puerto Rico government entities far into non-investment grade (‘junk’) territory raising the cost of the borrowing that all governments must do to more than 10%.  With more than $72 billion in existing debt – that will take $164 billion to pay back. Puerto Rico has drastically increased taxes and cut spending, reducing its public workforce and their pensions. But these measures and greater efficiencies being undertaken today have not been sufficient to counteract the territory’s continuing economic spiral downwards.  The Puerto Rico Electric Power Authority (PREPA), overly dependent upon expensive foreign oil, although it is converting to more cost-effective natural gas as well as to solar power, is currently carrying $9.3 billion in debt. With its customer base shrinking with the economy and population loss, it has been unable to pay creditors all amounts due since last July and is widely expected to default on its $400 million bond interest and principal payments due this July 1. PREPA’s financial collapse would have a devastating effect on other elements of government in Puerto Rico, further worsen the ailing insular economy, and result in needless losses for millions of people throughout the States as well as in the territory.

Anticipating its inability to meet all obligations, the insular government, enacted a law in June of last year that would have permitted PREPA and a few other government instrumentalities to go through a bankruptcy-like process. Bankruptcy represents a road out of excessive debt and a way to attract new investment from U.S. individuals and institutions who would benefit from tax-free interest on Puerto Rican bonds. In February, however, a Federal judge ruled that only Congress can authorize a bankruptcy process for Puerto Rican government entities. The Federal Bankruptcy Code provides States with the authority to restructure their financial obligations but does not give the Commonwealth the same power.

Pedro Pierluisi, Puerto Rico’s Resident Commissioner, has sponsored a bill in the U.S. House that would give the territorial government the authority of a State to enable municipalities to use the provisions of the Federal Bankruptcy Code for such situations. The Puerto Rico Fiscal Stability Coalition stands in full support of this legislation, as the ability to restructure debts is the only viable beginning of economic recovery in Puerto Rico.

If the Federal government does not take action to relieve budgetary pressure in Puerto Rico, it will be defaulting on its duty to these American citizens and, possibly creating a need for additional federal aid to the territorial government. Without the safety net of Chapter 9: the economic and social prospects of the islands will worsen, perhaps permanently; the people of Puerto Rico will have to contend with counterproductive suffering; many more will move to a state; the investments and retirements of millions of citizens throughout the States will be diminished; and the federal.

Power Delegated to the States


Bankruptcy laws are an integral part of the U.S. system of governance and so necessary to a robust economy that they are provided for in the Constitution. Article 1, section 8 of the Constitution states that “The Congress shall have Power To…establish…uniform Laws on the subject of Bankruptcies throughout the United States….”

The Founding Fathers believed that a coherent and consistent national power over bankruptcy was so essential to economic progress that there was almost no debate about the issue at the Constitutional Convention.  As James Madison observed in  The Federalist  No. 42, “The power of establishing uniform laws of bankruptcy is so intimately connected with the regulation of commerce, and will prevent so many frauds where the parties or their property may lie or be removed into different States that the expediency of it [i.e., Congress’s power to regulate bankruptcy] seems not likely to be drawn into question.”

Beyond providing for a uniform right to declare bankruptcy in the United States, however, it remained unclear after the ratification of the Constitution whether the power to oversee bankruptcy processes rested with the State or Federal governments. In 1902, the Supreme Court ruled in Hanover Bank v. Moyses that bankruptcy rulings should be “geographically” uniform – that is, debtors and creditors in different States should receive the same treatment.

Chapter 9 of the Federal Bankruptcy Code authorizes States to choose to enable their municipalities to file for bankruptcy. H.R. 870 does not seek to modify this law beyond including Puerto Rico within the definition of a “State” for this specific purpose. If the bill passes, Puerto Rico would be able to authorize its municipalities, which includes instrumentalities such as power or transportation authorities, to restructure their finances according to the terms of Federal law. Not all States have chosen to exercise the authority and most that have limit the authority.

The same would be true of Puerto Rico. Although the territory wants the authority, it does not want to exercise the authority unless absolutely necessary. If a Puerto Rican government instrumentality was authorized to exercise it and chose to, it would have to convince a Federal bankruptcy judge that it had done all possible otherwise to reach an agreement with its creditors first.

As a new nation designing the tenets of its government, the United States saw a clear need to provide for bankruptcy as a solution to excessive debt or to assist individuals, businesses, or government entities that had suffered economic losses too great to bear.  In achieving a level of prosperity that enables it to incorporate non-state territories such as Puerto Rico, the United States assumed a significant burden of responsibility for the economic future of a people who lack the sovereignty to enact their own bankruptcy laws. It even authorized the territorial government to issue bonds and provided for the tax treatment of these bonds everywhere in the Nation. If it denies Puerto Rican government entities and municipalities the right to declare bankruptcy, the United States will exclude Puerto Rico from the very solution to economic crisis its Founding Fathers found essential beyond debate in the founding of our Nation.

Lack of Inclusion Endangers Millions of Citizens NATIONALLY


After phenomenal growth in the 1950’s and ’60s, the Puerto Rican economy has lagged that of the states for four decades and been in recession for eight of the last nine years. National and international economic policies and development and Puerto Rico’s lack of power in deciding national economic laws is a major factor. With a shrinking population and economy, and the territory’s debt approaches $165 billion or approximately 150 percent of its GDP. Unemployment is almost 12 percent — twice that of the nation — with two-fifths of potential workers in the labor force compared to more than three-fifths in the States. 45% of all citizens live below the poverty line. All in all, the debt burden of the Commonwealth government is unsustainable by almost any measure.

Puerto Rican bonds are integral to the American bond market, and many in the United States will be affected negatively by the consequences of not passing H.R. 870, particularly those invested in municipal bonds. Morningstar says as much as 80% of Puerto Rico’s $70 billion plus debt is underwritten in muni-bond funds, and 180 mutual funds in the USA and elsewhere have at least 5% of their portfolios in Puerto Rican bonds. (USA Today) Municipal bonds are held by several prominent mutual funds, such as USATX, USTEX, STSMX, STXAX, and MITFX. According to The Economist, “Puerto Rico carries outsized importance in America’s almost $4 trillion municipal-debt market.”

2013 was the worst year in history for municipal bond funds in large part because of the dire economic situations in Detroit and Puerto Rico. Subsequently, Detroit filed for bankruptcy, but key municipalities and government corporations in Puerto Rico are unable to do this because Puerto Rico does not qualify as a state under Federal Bankruptcy code. Recent events have led to the downgrading of bonds held by United States interests. In February 2015, Moody’s Investors Service downgraded Puerto Rico’s general obligation bonds, indicating that “the outlook for Puerto Rico remains negative. Weakening liquidity and economic deterioration may put increasing pressure on the commonwealth’s credit position in coming months, heightening the risk of default on central government obligations. Efforts to access the capital market, if successful, may bolster liquidity in the short term but will not address fundamental economic and fiscal stress.” In particular trouble is the Puerto Rico Electric Power Authority or PREPA, which currently carries $9 billion plus in debt. “A wide variety of analysts expect the Puerto Rico Electric Power Authority (PREPA) to default on its July 1 interest and principal payment, according to CreditSights, an independent research firm.” (Schwab) If Puerto Rico is unable to meet its financial obligations and defaults, countless American investors are guaranteed to lose money, and the American bond market itself could take a dangerous downward turn.

Leading investment firms, rating agencies, and economists are convinced that passing H.R. 870 will provide Puerto Rico with the tool it needs to recover from its dire economic situation and honor its obligations to American investors. A respected investment firm surveyed approximately two dozen financial institutions, investment advisory firms, mutual funds, hedge funds and others market participants, and found that “there is nearly unanimous agreement that application of the Chapter 9 regime to Puerto Rico’s agencies, instrumentalities and political subdivisions is a reasonable approach and would not impair the normal functioning of the marketplace.” Fitch Ratings also issued a special comment, entitled “Chapter Extension Would Be a Positive for Puerto Rico,” stating that H.R. 870 “would be a positive and important development for Puerto Rico and holders of debt of its public utilities and public instrumentalities.” Addressing this debt crisis may also mark the beginning of the long road out of recession for Puerto Rico as its government finds surer financial footing and can begin building toward new investments and sources of internal revenue.

Lack of inclusion threatens federal budget


If Congress does not pass H.R. 870 and extend to Puerto Rico the right to authorize its municipalities and government entities to have their finances restructured under Chapter 9 of the Federal Bankruptcy Code, Puerto Rico may soon reach a height of budget crisis that can be addressed only through a massive bailout package from the Federal government.  Puerto Rico is currently responsible for debt totaling approximately $165 billion USD, or 150% of Puerto Rico’s Gross Domestic Product, and may reach a point in the near future at which some government entities in the territory become insolvent.

Government bailouts have become increasingly and disconcertingly necessary in the United States in recent decades, including $45 billion to Bank of America in 2009, $79 billion to General Motors in 2008, and the municipal bailout of New York City in 1975, which cost taxpayers the equivalent of $10 billion in 2015 dollars. In each of these cases, a plan for repayment of debt was carefully structured to minimize ultimate taxpayer expense, but in the case of the auto industry bailout, more than $9 billion was never repaid. For Puerto Rico, managing existing debt is only one barrier to economic prosperity: lack of sustainable industry, lack of jobs, and lesser Federal assistance in Federal health and social programs all inhibit the growth of the Puerto Rican economy, so the prospect of Puerto Rico accomplishing timely repayment of a bailout is highly questionable.

In addition, Puerto Rican bonds are a staple of the American bond market. The bonds are provided for by federal as well as local law under federal law; interest from these bonds are exempt from Federal, State, and local taxes, making them very appealing to investors. For this reason, The Economist magazine wrote that “Puerto Rico carries outsized importance in America’s almost $4 trillion municipal-debt market.” Even as the U.S. economy has struggled in recent years, bond markets have presented little risk domestically, but, according to a 2013 Forbes analysis, “a crisis in Puerto Rican could bring this risk directly to North America, with immediate implications for states like Illinois and California first, provinces like Ontario and Quebec second, and eventually the U.S. government itself. Along the way, a Puerto Rican crisis can also slow any momentum in the U.S. economy by slowing or delaying state and local government spending, and even push some smaller distressed local governments over the edge and into bankruptcy by closing off their own bond market access.”

The bailout that would be necessary in this case would threaten the Federal budget in a way that can be avoided with the passage of H.R. 870. If not, the bailout for the Puerto Rican government would be on the scale of bailouts of New York City, General Motors, or Lehman Brothers.  Unlike these bailouts, Puerto Rico’s current dismal economic status would make repayment of any bailout nearly impossible even with further deep spending cuts and tax increases. If the aid could ever be paid off – which is highly unlikely, it would take at least many decades. More likely, the massive migration taking place from Puerto Rico because of its economic reversal would accelerate enormously with impacts upon the States. Taking action now by passing H.R. 870 is the surest way to avoid this series of potentially disastrous events and ensure the future economic stability of Puerto Rico and the mainland interests invested there.