On May 2, 1975, the heads of New York’s three largest banks told Governor Hugh Carey they would no longer buy New York City’s debt. With that, the world’s financial capital was pushed to the brink of default.
The conditions that gave rise to New York City’s fiscal crisis four decades ago are mirrored in Puerto Rico today: a recessionary economy, shrinking population and years of unsustainable borrowing to pay bills.
Yet as the Caribbean commonwealth struggles with $73 billion of debt, it may not be able to follow the path that saved New York. There, political and labor leaders ceded power to an unelected board that oversaw the city as it cut tens of thousands of jobs, froze employee wages and raised taxes.
All that was made easier because the U.S. government stepped in with loans that left Wall Street willing to buy the city’s bonds, an option that doesn’t seem open to Puerto Rico.
“We had extraordinary leadership,” said Richard Ravitch, an adviser to Carey during the crisis. “Everybody ultimately did what they swore they wouldn’t do.”
The same can’t be said yet for the island of 3.5 million people 1,600 miles (2,600 kilometers) to the south. Its legislature is mired in political discord. Washington has shown little interest in rescuing the teetering commonwealth. And investors have pushed yields on Puerto Rico’s 20-year tax-exempt bonds to about 10.5 percent, higher than on Argentina’s benchmark dollar bonds, in default since July.
Puerto Rico’s effort to repair its finances was cast into disarray last week, when lawmakers rejected Governor Alejandro Garcia Padilla’s proposed tax overhaul. Even some members of his party voted against it. Without the new revenue, Puerto Rico officials said they may not be able to sell $2.9 billion of bonds that would raise money needed to keep the government from shutting down within months.
Puerto Rico warned Thursday that without the borrowing, the government may run out of cash by Sept. 30. The commonwealth said it could place a moratorium on debt payments or put revenue from public corporations toward general obligations next fiscal year if the government can’t cut spending or generate more revenue, according to a quarterly filing posted on the Municipal Securities Rulemaking Board’s website.
“The political system has shown it’s not capable of fixing this on its own,” said Robert Donahue, a managing director at Municipal Market Analytics, a Concord, Massachusetts-based firm.
The pressure on Puerto Rico has been building for years. A government index tracking the economy has dropped in every year but one since 2006, leaving an unemployment rate of 11.8 percent, more than twice the national level. Its population has declined by almost 300,000 since 2004. With spending growing faster than revenue, Puerto Rico has borrowed to close budget deficits, causing its public debt to double over the past decade.
The situation echoes New York in the 1970s, when the oil shock and recession eliminated thousands of jobs and racial tensions caused middle-class professionals to leave for the suburbs.
“These are both political entities faced with an economic problem in which the use of the debt markets was supposed to ameliorate it and instead seems to be exacerbating it,” said Phil Fischer, head of municipal research at Bank of America Corp. in New York.
One path that was open to New York isn’t there for Puerto Rico: The commonwealth can’t file for bankruptcy to reduce its debts, and a bill that would allow its agencies to hasn’t advanced in Congress. Governor Carey opted for negotiations out of court.
“Bankruptcy would have been an admission that democracy couldn’t solve a problem,” said Ravitch.
Instead, New York handed its finances to an emergency control board set up by the state. The board gave city officials political cover to reject labor contracts, withhold raises and cut spending. It also overhauled the city’s financial controls and reporting, helping it regain credibility with investors.
Congress has the power to create a control board to impose unpopular austerity measures on Puerto Rico, said Arturo Porzecanski, director of the International Economic Relations Program at American University’s School of International Service in Washington. He said Congress is partly responsible for the debt crisis because it gave Puerto Rico a “free pass” into the capital markets by exempting its debt from federal, state and local income taxes.
“Congress opened the floodgates and so now Congress should take responsibility,” he said.
Washington has shown little interest in rescuing Puerto Rico because the commonwealth isn’t seen as a threat to the financial system, according to Daniel Hanson, an analyst at Height Securities LLC, a Washington-based broker dealer. In 1975, Felix Rohatyn, the banker who helped rescue the city, argued that a New York default would roil global markets.
“Puerto Rico is simply not politically or financially important enough,” Hanson said. “Puerto Rico is not in a position to get any meaningful relief without some kind congressional action, and frankly, there is no congressional action coming.”
Such federal assistance was key to New York’s rescue. A month after the control board’s creation, the Daily News famously pilloried President Gerald Ford’s initial reluctance to provide aid to New York with the headline: “Ford to City: Drop Dead.”
In exchange for $2.3 billion in short-term federal loans, New York’s leaders, banks and labor unions had to accept tough conditions.
The city raised $200 million in new taxes. Public-employee unions agreed to job cuts and a wage freeze, while their pension funds bought new city debt. Tuition was imposed at City University of New York and transit fares raised. For their part, banks exchanged city notes for long-term bonds, while payments to other holders of short-term debt were postponed.
Puerto Rico Governor Garcia Padilla said last week that defaulting on the commonwealth’s bonds would be a mistake and that he’s crafting a plan to steady the junk-rated island’s finances.
El Nuevo Dia, a Puerto Rican newspaper, said the government is planning $1.5 billion in budget cuts, while the chairman of the Senate’s finance committee said lawmakers could raise the island’s 7 percent sales tax by two to three percentage points.
The U.S. Treasury Department has been offering Puerto Rico advice on how to ease its financial burdens and make sure it receives all of the federal funding it’s eligible for, about $6 billion a year. Bond-market analysts have said they don’t anticipate more extensive aid, such as loan guarantees, that would require approval from Congress.
Porzecanski, the American University professor, said Washington may have to get involved to keep the crisis from jeopardizing public safety on the island and the retirement accounts of Americans. About half of U.S. municipal bond funds own the commonwealth’s debt, according to Morningstar Inc.
“We can pretend that Puerto Rico isn’t our problem, and that because they have an elected government they can take care of the situation,” he said. “Or we can look at the facts.”
For more, read this QuickTake: Puerto Rico's Slide