A Senate Bailout of Puerto Rico By Another Name?

by John Fund

Puerto Rico has been cursed with more bad government than any other place under U.S. jurisdiction. That’s why it’s about to miss a $2 billion debt payment this Friday, plunging it into more chaos. Over 30% of the island’s revenue now goes to debt payments. 

But the U.S. Senate may vote to make things worse this week by passing a rescue package that suspends the constitutional rights of bondholders in the island to collect on their debts.  Debt holders will essentially have no legal means to secure repayment.

The Senate is acting on its version of a House bill that passed last month that sets up an oversight board to monitor Puerto Rican finances and the power to override some destructive laws. That’s all well and good, but the bill comes with a poison pill by allowing write-downs of bonds in which payment is guaranteed by Puerto Rico’s constitution. 

“This is the first time that a constitutional guarantee for bond repayment has been breached by the Congress,” says Rep. Tom McClintock of California, who opposed the bill.   He notes that Congress explicitly reaffirmed Puerto Rico’s obligation to pay its debts back in 1961.

Lured by such guarantees, investors poured money into Puerto Rico. Logan Beirne, a lecturer at Yale University, says that if the Senate passes the House bill “Puerto Rico will be allowed to walk away from the negotiating table rather than have to negotiate a legal pat forward with creditors.”  

The Republican leadership in the House was able to overcome the legal objections of many GOP members largely by convincing them the bill did not represent a federal “bailout” of Puerto Rico’s spendthrift ways because no direct federal dollars will be spent. Instead, the Rule of Law will be sullied because Puerto Rico will have the freedom not to pay the full amount of its debt obligations.  In the short term, that may help the island but it will also chill its ability to issue new debt in the future.  The island will then use that failure to try to escape the major fiscal reforms it inevitably will have to initiate.

GOP leaders had to rely on Democratic votes to pass the bill.  While over 85% of Democrats voted for it, less than 60% of Republicans did.  Several Republicans pointed out that Congress has consistently made matters worse when it has meddled in Puerto Rican affairs. In the 1970s, it raised the island’s minimum wage to match that of mainland states. It imposed the Jones Act, requiring ships transporting goods between any two U.S. ports to be built in the U.S.  That ensure the cost of shipping a cargo container from any U.S. port to Puerto Rico is nice as expensive as shipping it to other nearby Caribbean ports. Congress also allowed a phaseout of federal tax incentives on the island to take effect in 2006.

The Federal Reserve also takes its share of the blame. Bond expert Bill Gross recently observed that “Puerto Rico follows Detroit not just because of overpraised benefits but because they cannot earn enough on their investment portfolios to cover the promises. Low/negative interest rates do that.”

The irony is that if Washington passes a short-sighted Puerto Rican debt-relief bill, it may still wind up handing taxpayers the tab.  There is no doubt a “takings” lawsuit will be led by bondholders claiming that Congress confiscated the value of their property by allowing Puerto Rico to shortchange tham on payment. If that lawsuit wins in the courts, you can bet Congress – meaning U.S. taxpayers – will be required to pay the bondholders whatever amount Puerto Rico didn’t pay.  That would simply be a bailout by another name. 

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