Let Puerto Rico Go Bankrupt
Proponents of Puerto Rican statehood have always said that the island's in-between status -- it's not a state, but not independent either -- leaves it with the worst of all worlds. The territory's fiscal crisis is illustrating the point.
Puerto Rico and its subdivisions amassed a lot of debt over the years, partly because the federal government gives them special treatment: Interest paid on their bonds can't be taxed anywhere in the U.S. And while federal bankruptcy law allows municipalities in states to file for Chapter 9 bankruptcy, municipalities in Puerto Rico can't do the same, because it isn't a state. That makes lending to them more attractive. But once they've borrowed more than they can repay, it makes it harder to clean up the mess.
Over the summer, Governor Alejandro Garcia Padilla said that Puerto Rico's $72 billion in debts were "not payable." He wants the federal government to apply bankruptcy law to Puerto Rico as though it were a state. Legislation to that effect is facing skepticism in Congress, especially from Republicans who say it would amount to a "bailout."
Usually, though, we use the words "government bailout" to describe the use of taxpayer funds to pay off the creditors of an insolvent institution. The bankruptcy bill would stiff the creditors, instead. Two conservative groups, Citizens Against Government Waste and Americans for Tax Reform, favor the bill because they think that the likely alternative is a real bailout -- Congress would spend money, they think, rather than let the island's electric company go dark because of its debts.
Other arguments against extending Chapter 9 to Puerto Rico are similarly wanting. Some opponents say it would "undermine investor confidence" in the island. Events would seem to have already done a lot of the undermining. In any case, that's an argument against having Chapter 9 anywhere, not just in Puerto Rico.
They also say it would be unfair to change the rules: Creditors lent in the expectation that bankruptcy law didn't apply to Puerto Rico. A better way to look at it is that loans always involve the risk that borrowers won't be able to pay back the money. That risk has come to pass: They aren't going to pay it back -- at least not in full and on time. Bankruptcy would let the consequences of that fact play out in a relatively orderly fashion, while reducing the exposure of mainland taxpayers.
Two other concerns of opponents are more serious. They say, first, that Chapter 9 is no substitute for the major reforms that Puerto Rico needs. In testimony before Congress, the economist Douglas Holtz-Eakin suggested that the island privatize its power utility and that Congress exempt it from the federal minimum wage. He added: "Chapter 9 would not increase economic growth. Chapter 9 would not alter the fundamental fiscal trajectory." That's true. But these aren't reasons to refrain from extending Chapter 9 protections; they're reasons to undertake reforms in addition to extending them.
Others say that Chapter 9 is insufficient because a lot of Puerto Rico's debt wouldn't be covered by it. Both that concern and the need for reform have motivated calls for a "financial control board" of the sort that Congress used to sort out the finances of Washington, D.C., in the 1990s.
But extending Chapter 9 would give Puerto Rico some relief and provide taxpayers some protection -- and Congress could write the law to provide more. Or it could opt for a financial control board, which could be a helpful way of combining reform and a debt restructuring. The main problem with the board idea is political: Congress may not be able to agree on something that ambitious. If it can't, it should at least allow the courts to relieve some of the debt burden. Creditors, not taxpayers, should take the hit for unwise loans.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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