Debt Crisis in Puerto Rico

Introduction

When people usually think about Puerto Rico, many things may come to mind. They may think about being in Caribbean paradise where the clear blue waters carry them away. They may picture themselves burying their toes into its white sandy beaches just to take that perfect Instagram picture as they reach for their Pina Coladas. However, this utopian image of Puerto Rico serves as a false reality of what’s truly happening on the Island. Unfortunately, Puerto Rico is struggling to pay its bills despite its attractiveness as a popular tourist destination. Since 2006, its economic woes has crippled its economy causing a wide-spread poverty, unemployment, and massive debt. Moreover, the Puerto Rican economic crisis has created a lack of opportunity and a mass exodus in which millions of Puerto Ricans are leaving the island. In a 2017 article published by Business Insider entitled “Here’s how Puerto Rico got into so much debt,” they concluded that the island owed over 70 billion dollars in debt to creditors.

When analyzing how things got so bad in the first place, there are some main factors that will be discussed in this paper. Factors such as legal loop-holes, territorial status, public debt, and lack of federal funding have all contributed Puerto Rico’s economic free-fall. Yet, there are also other factors such as mismanagement of funds, preferential financial treatment for states vs territories, predatory lending, lack of federal oversight, and corruption will all be discussed. It is the intent of this paper to explain these important factors while uncovering how these things came to be in the first place. In order to do this, we must first go back in time to explain how Puerto Rico’s history and its long relationship with the United States is affecting their current economic situation today.

Brief History of the Island and Its Relationship With the United States

Puerto Rico is a Caribbean island within the Greater Antilles that was colonized under Spanish rule for over 400 years. Once the 20th century arrived, the United States gained control over the island after going to war with Spain. For over 17 years, Puerto Rico’s government status remained in limbo until 1917. According to the CIA world fact-book, Puerto Rico was given territorial status in 1917. “The island was ceded to the U.S. as a result of the Spanish-American War.” Soon thereafter, the island established its own constitution which was similarly modeled after the U.S. version. The U.S. government allowed Puerto Rico to have a governor and one representative in congress. The people on the island were given special citizenship status by the government of the United States. However, their status placed limits on their ability to vote in federal elections because Puerto Rico was not a state.

In the eyes of the federal government, Puerto Rico was only seen as an unincorporated territory. Due to the Island’s territorial status, their Congressional representatives voting powers were also limited in some form or fashion. Technically called resident commissioners, Puerto Rico’s representatives were only seen as tokens rather than real congressional members. Therefore, its status as a territory kept the island’s representatives unable to vote for or against proposals, budgets, tax plans, and other legislation that would affect the island.

Puerto Rico’s territorial status causes its economy to thrive

During the 1940s, the 1st of Governor of Puerto Rico Luis Marin was concerned about how poor and underdeveloped the island was compared to the states. Marin, who would later be considered the father of modern Puerto Rico, had a better vision for the future of the island. He decided to create an economic development initiative called operation bootstrap that would attract American corporations to set up factories and offices in Puerto Rico. According to Brown University Library.edu, “Operation Bootstrap was fundamentally about modernizing the Puerto Rican economy. Much of it involved providing tax exemptions to American corporations who set up shop in Puerto Rico. These corporations were then able to capitalize on the lower costs of labor on the island, which further improved their bottom line and made doing business in Puerto Rico even more attractive”

In other words, Governor Marin saw the tax breaks and cheap labor as the triggers that would tempt American companies to set up shop on the island. Specifically, Puerto Rico’s territorial status would make it where companies wouldn’t have to pay as much in federal taxes as they would in the states. Puerto Rico decided to eliminate their corporate tax. Instead, the trade-off would be thousands of newly created jobs causing an increase in sales and property tax revenue. Operation bootstrap would also give exposure to the American elite who may want to relax in the winter in Puerto Rico causing boosts in tourism, and a higher standard of living on the island. Although it took a while but by 1949, the Puerto Rican economy began to skyrocket thanks to the manufacturing industries setting up shop on the island. Brown University also notes that, “The Department of Commerce valued manufacturing in Puerto Rico in 1949 at $93 million. By 1967, it estimated that manufacturing was producing $621 million for the island. Evidently, Operation Bootstrap successfully industrialized the island. Perhaps more importantly, it successfully shifted the Puerto Rican economy’s dependence from agriculture to industry in less than twenty years.”

Elimination of Corporate Tax Breaks Negatively Affects Puerto Rican Economy

Despite the economic upturn, Puerto Rico’s new-found prosperity would be short lived as U.S. Congressional legislation became tougher on corporate tax breaks. At the time, the U.S. Federal government was very lenient on taxing companies because they created millions of jobs and brought in so much revenue. The American government had experienced the industrial revolution, WWI & II, and the great depression. Therefore, government’s agenda was to never to penalize companies because its economy relied heavily on these companies. During the 1940’s, there had been a loop hole for corporations who wanted to qualify for tax exemption status in Puerto Rico. Those who moved their operations to the territory enjoyed the luxury of not paying certain federal taxes.

Laws such as 26 U.S. Code § 931 had provided a tax exemption for these companies whose business operations originated in Puerto Rico. However, as time went on, Congresses would become less lenient on tax breaks and would ultimately roll-back many of the earlier tax legislation. By 1996, many corporations on the island began to downsize and lay off workers. The amount of businesses that were coming to the island to set up shop were decreasing. Poverty and unemployment began to rise. Ultimately by 2006, these tax breaks were fully eliminated and its effects negatively impacted the Puerto Rican economy. By this point, corporations began leaving the island, laying off their remaining workers. Once the corporations were gone, its economy sunk like the titanic leading to a deep recession.

Puerto Rico’s Economy Worsens Due To Its Territorial Status

During the beginning of the Puerto Rican recession, the island was facing a major dilemma. The government had to make an appropriate decision on how to deal with its emerging debt problem. Ultimately, they decided to borrow money by allowing investors through banks to buy bonds. From a temporary standpoint, allowing these bonds to be issued seemed like a great idea. However, in reality there were three major problems with these bonds. First, Puerto Rico’s territorial status allowed banks and investors to take advantage of their need for cash. Since Puerto Rico was not a state, there was no real federal oversight presence over the practices and issuing of these bonds like in the states. Therefore, the island’s territorial status made them vulnerable to investors whose goals are to engage in predatory lending practices.

In an article by NPR.org entitled: “How Puerto Rico's Debt Created A Perfect Storm Before The Storm” they discuss how the island’s status led to banks trying to capitalize off their misfortune. They go on to say, “Many of the bonds were specifically designed to be sold to Puerto Ricans, packaged into special funds that were less transparent than anything regulators would allow on the mainland. Regulations against things such as banks recommending their own bond deals to investors didn't apply on the island.” This validates my argument that banks were actively trying to capitalize off of the Puerto Rican debt crisis, and its territorial status. The second problem with these bonds dealt with the ability for Puerto Rico to pay these bonds back. Banks were essentially selling bonds to investors like hot cakes while Puerto Rico continued to take their money with no real plan to pay it back. NPR.org goes on to say, “When you start borrowing long term just to pay next month’s payroll, you know you are going down a rabbit hole. It was crazy. The government was borrowing at an incredible clip”.

Banks on wall-street such as UBS and Morgan Stanley knew that the Puerto Rican government could not pay these bonds in the long term. However, these banks kept pushing their clients to invest their retirement and pensions into Puerto Rico. They wanted to receive steady commissions from the sale of these bonds and greed drove their aggressive sales tactics. The last problem dealt with banks bailing out on its investors after Puerto Rico’s debt became too large to manage. This was a huge problem for investors who may have put their whole life’s savings into these bonds. The whole problem started when there were too many bonds being sold. There were so many investors and not enough potential to pay them all back plus interest. Therefore these notes status became junk bonds.

When this happened, NPR.org goes on to explain how the banks responded. They mention that “The banks got out, and everybody else got stuck with the bill. Most of the general public didn't understand what was going on. The darkness of this bond deal made a lot of people in Wall Street happy, but it was immoral in many ways. Fifteen months later, Puerto Rico announced it couldn't pay its debt. The island was broke. The bond funds crashed and many Puerto Rican investors lost savings, retirement funds or their pensions.” The banks didn’t care about the island nor its investors. As long as they got their commission, they were determined to ride that horse until they couldn’t ride it anymore.

Puerto Rico’s financial mismanagement is another factor that led to the plummeting value of its bonds. When the islands bond classification became junk status (Junk bonds), it caused potential investors to also leave. This hurt the island’s image and all current investors involved because this meant that there was no certainty about whether they would get their money back. Puerto Rico’s financial mismanagement was so bad that they were borrowing money to pay off the interest on their debt. Despite governments mismanagement and inability to be fiscally responsible, there are others to blame for the island’s economic crisis. In an article by business insider entitled, “Here’s how Puerto Rico got into so much debt,” they another important entity that must share the blame. They explain that the U.S. federal government is also at fault.

“Underlying all of these monumental issues is the real kicker. Puerto Rico has little ability to speak up for itself in Washington, allowing the federal government to enact policies that affect it without its own consent.” Not only doesn’t Puerto Rico have power in making their own decisions, but they are also treated differently concerning federal appropriations as compared to the states. Business insider goes on to say, “while more than 60% of Puerto Ricans are on the programs’ payrolls, the territory receives much less federal funding for its insurance programs than do states on the US mainland, meaning that Puerto Rico has to finance the remaining costs itself. This is yet another factor in the growth of the island’s debt.” When the federal government does this, they are sending a message that states will always be top priority over territories.

Puerto Rico’s territorial status also plays a factor in whether or not it can file for bankruptcy. In another article by business insider, they explain the “3 main reasons why Puerto Rico can’t declare bankruptcy.” They argue that chapter 9 bankruptcy laws apply to municipalities of states. Therefore, there is a technicality for states. Although states cannot declare for bankruptcy, their municipalities could. Puerto Rico’s municipalities do not get the same benefit because of its status as a territory. However, there is a bill in the senate that would seek to change this rule by including municipalities of territories. According to the Supremacy clause within article VI paragraph two of the U.S. Constitution,

“This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” This clause means that congress has the power to stretch protections, provisions, and authority of federal law to include all territorial entities. The bill that is being presented by Senator Chuck Schumer and Senator Richard Blumenthal intends to do just that. Moreover, “On June 29, the governor of Puerto Rico announced that 72 billion of the commonwealth’s debt was unpayable. This debt burden amounts to more than $20,000 for every man, woman, and child.”

Hurricane Maria and its effects on The Puerto Rican Economy

In the early months of 2017, the Puerto Rican economy was still in really bad shape. Many people on the island were in poverty and opportunities were hard to come by. Yet, when the people of Puerto Rico didn’t think things could any worse, Hurricane Maria happened. Puerto Rico took a series devastating blows from Mother Nature as the hurricane swept from east to west leveling the island. The storm damaged numerous buildings and other property leaving severe damages to infrastructure and displacing thousands of Puerto Ricans. Hurricane Maria brought the island to its knees. It created a situation where the island need immediate aid. According the National Oceanic and Atmospheric Administration’s Office for Coastal Management (NOAA), the rough estimate of the damage done to Puerto Rico is around $90 Billion dollars. CBS news.com mentions these costly damages to infrastructure an article entitled: “Puerto Rico's grim prognosis: The island may never recover.” They mention how hard it is to find funding to fix the island.

CBS news.com goes on to say, “Puerto Rico was already insolvent before the 2017 storm, with creditors and the island's government deep in negotiations about how to jumpstart the economy or strip it bare to pay off $70 billion owed to bondholders. And the island's government owes another $50 billion it doesn't have to cover current and future pensions. Even before Maria, half a million people had left Puerto Rico and its economy had been steadily shrinking since 2005. After the hurricane, there's even less to work with.” It doesn’t take rocket science to understand that 70 billion in debt before hurricane Maria plus over 90 billion in infrastructure damages equals a 160 billion deficit. Puerto Rico knows that it must find a way out this debt prison to stabilize its economy. Many people point to its territorial status as an argument that the repayment of debt is not solely on Puerto Rico.

There are many people who believe that the federal government shares a certain level of responsibility for paying off the debt. However, there are certain political officials that do not agree about the responsibility that the federal government has to help Puerto Rico clear its debt. In fact, some people may not agree with the amount of aid proposed to the island in the wake of the hurricane. These people such as the President of the United States, have been vocal on not financially supporting Puerto Rico. PBS NewsHour recorded President Trump’s remarks during a visit to the island after the hurricane. As the President was addressing the devastation, he said “I hate to tell you Puerto Rico, but you’ve thrown our budget a little out of whack because we’ve spent a lot of money on Puerto Rico.” However, according to a Washington post article about disaster relief funding, Puerto Rico makes the claim that it hasn’t received enough federal funds to bring the island back to normal operation.

HUD has given Puerto Rico 20 billion in disaster relief funding. However, 20 billion has only put a dent in the problem. In total according to nbcnews.com, “the federal government allocated $ 40 billion for disaster recovery in Puerto Rico but Puerto Rico incurred in at least $ 90 billion in damages.” To this day, politicians disagree with how much Puerto Rico really needs and whether the U.S. federal government should financially help. With all that has happened to Puerto Rico within the last 10 years, many economists believe that it would take decades to pay off the debt that they have accumulated.

Plans for Restructuring Puerto Rico’s Debt

On March 13, 2017, Puerto Rico’s Fiscal Agency and Financial Advisory Authority (AAFAF) released a plan to Restructure their debt by reducing general spending and increasing taxes. Their plan also includes specifically reducing healthcare spending, revenue enhancement, and Pension reform over a 10-year period. They want this plan to help them restructure their debt so that they can be on the path of economic recovery. They believe that the first step on path of recovery is creating a financial mission. In their financial mission, “The government believes communication, grounded in fiscal responsibility, can create the opportunity for maximum consensus among stakeholders and pave the way for Puerto Rico’s long-term fiscal stability and economic growth.” They follow up this mission statement by explaining their desire to “reduce the fiscal gap by 39.6 billion while also creating a 10-year cash flow surplus of 7.9 billion.” This essentially means that Puerto Rico wants to cut its deficit by more than half within ten years. This plan also means that they won’t be paying anything on their debt for 5 years. Instead, they expect to consolidate their funds and began paying lump sums by the 5-year mark. Even though there are multiple problems with this plan, the overarching idea is good step into the right direction given the years of bad decision making and mis-management by politicians.

in 1996, as the economy began to gradually decline, the island’s politicians decided to borrow money it didn’t have rather than make necessary spending cuts. Puerto Rican politicians felt that they would lose re-election bids and deal with widespread protest if they were to enact spending cuts. Therefore, they found it rational to borrow money while continuing to spend that money at the same levels as previous years when they had more revenue coming in. To this day, Puerto Rican politicians continue to borrow money and make fiscally irresponsible decisions despite their economic crisis. According to The Heritage Foundation, “At $72 billion, Puerto Rico’s debt is now more than 100 percent of its gross national product (GNP). The debt does not include another $35 billion in unfunded pension liabilities and other unfunded liabilities, which also need to be considered. Confronting this massive debt will require difficult political decisions.”

If the Puerto Rican government had not engaged in financial mismanagement there wouldn’t have been any debt in the first place. Instead, they began to borrow to the point that their debt became a fiscal avalanche headed right for their economy. Despite Puerto Rico’s mismanagement, the federal government failed to conduct oversight and review the financial needs of the island. The federal government also engaged in preferential treatment when it came to appropriations. Most importantly, the Federal government does not give Puerto Rico the same congressional representation as states. Even though Puerto Rico has a representative in congress, they don’t have any real voting power. This essentially means that Puerto Rico doesn’t even get an opportunity to vote on decisions which directly or indirectly affect them. However, there are some ways in which congress can maneuver around the rules so that Puerto Rico’s representative can have some say in certain decisions. There are some federal politicians who believe that the U.S. government has a responsibility to help Puerto Rico clear or restructure its debt.

While researching how the federal government appropriates money to territories, I made an interesting discovery. At the Federal level, there is a plan to restructure Puerto Rico’s debt through the house committee on natural resources. The plan is called P.R.O.M.E.S.A. (Puerto Rico Oversight, Management, and Economic Stability Act). When I read this, I thought that there must have been an error or typo. Why would a natural resource committee be in charge of financial appropriations and oversight and for a U.S. territory? Then, I began digging deeper into the members who make up that committee and found something very interesting. The current Puerto Rican representative Jennifer Gonzales colon sits on the same house committee. Therefore, she gets some decision making power and she can also influence her colleagues on the committee to a certain extent.

According to H.R. 5278 within the CBO June 2016 cost estimate if passed, “the committee would be responsible for overseeing the fiscal and budgetary affairs of certain U.S. territories.” The bill would also “automatically establish an oversight board for the commonwealth of Puerto Rico. To help Puerto Rico address its mounting financial difficulties, the bill would also establish a seven-member Financial oversight and Management Board along with establishing a congressional task force to recommend changes to federal laws and activities that would support economic growth in Puerto Rico.” According to the PROMESA plan, the oversight board would be tasked with overruling any decision that could negatively impact the Puerto Rican economy. Therefore, any decisions made by any legislative official, public official, or governor could be legally overturned.

In an article published by nbcnews.com entitled, “here’s how PROMESA aims to tackle Puerto Rico’s debt,” they outline how PROMESA would work. First, they mentioned that the bill was approved in the senate 68-30. President Obama would later sign the proposal in July 2016 making PROMESA official law. Secondly, the new law would force Puerto Rico to balance their budget and set up a debt restructuring if there’s not one currently in place. Finally, the fiscal control board will act with autonomy from the government of Puerto Rico. Overall, the PROMESA plan is designed to provide crucial federal oversight into a financial situation that has spun out of control.

Possible Statehood and Conclusion

Currently there is a bill in the U.S. House of Representatives that would push for Puerto Rico statehood. Democratic lawmakers believe that statehood will ensure Puerto Rico’s economic recovery in the future. Allowing Puerto Rico to become a state would also help them be eligible to file for Chapter 9 bankruptcy. In addition to this, statehood would give Puerto Rico voting representation in congress and therefore they can vote on things that affect them. Although, I agree that Puerto Rico should be a state I don’t know if the bill will pass through both chamber. The Senate is controlled by a Republican majority and they will stand with the president in not allowing Puerto Rico to become a state. I believe there are two main reasons why certain lawmakers don’t want Puerto Rico to achieve statehood.

The first reason deals with restructuring how we re-appropriate money so that we could include Puerto Rico into the group. Some people just don’t find the island as important as any of the current states. The Second and more political problem is that allowing Statehood would destroy our political and electoral college system. We would have to restructure the electoral voting system to include Puerto Rico. This would also alter representation in both the house and senate. For a republican controlled government, the last thing they would need is giving a liberal leaning island statehood because those people will almost certainly not vote for the Republican Party. In conclusion, the island’s territorial status has caused some unfortunate financial situations to occur and something must be done. The people of Puerto Rico are citizens of the United States and deserve all of the rights and privileges bestowed unto them. Therefore, the U.S. Federal government is responsible for ensuring their ability to have access to the same opportunities afforded to those who are on the mainland. There should be no more limbo about the financial future of Puerto Rico because the federal government shares the responsibility. Finally, banks should never be able to get off scotch free after helping pull that Ponzi scheme on the island. As for the investors, Puerto Rico should still set up a feasible repayment plan because a lot of honest, hardworking people lost their life’s savings.

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