Puerto Rico’s legislature plans to vote on a budget proposal on Tuesday that would cut hundreds of millions of dollars in spending, in an effort to stave off a looming debt crisis that is larger, by several factors, than the one that bankrupted the city of Detroit.
Unlike Detroit, the U.S. territory cannot declare bankruptcy, because it is treated like a state under federal bankruptcy law.
Still, Puerto Rico’s governor Alejandro Garcia Padilla told The New York Times, and then the world, that the commonwealth can no longer pay its debts, which total more than $72 billion. He wants to delay debt payments and negotiate more favorable terms with creditors — in essence, what bankruptcy would have facilitated.
“This has been a slow motion crisis since 2006,” says Juan Carlos Hidalgo, a Latin America policy analyst at the Cato Institute. “The Puerto Rican economy has entered a death spiral, investment is flowing out … and the cost of getting new debt has risen significantly.”
In recent years, Puerto Rico has tried to slash its way out of the problem by making spending cuts. It recently raised its sales tax, and previously had cut some corporate taxes to encourage companies to locate to the island.
Still, the territory’s problems persist, because of the magnitude of its debt load in relation to its struggling economy. Unemployment is near 14 percent. This has caused a lot of Puerto Ricans — who are U.S. citizens — to relocate to the mainland, plummeting real estate values on the island and worsening the economic malaise.
“Poverty is already very high. Very few people have jobs,” says Barry Bosworth, a senior fellow at the Brookings Institution, who thinks the U.S. government will eventually have to intervene in order to find a more permanent solution to Puerto Rico’s problems.
“They need some oversight” to renegotiate debts in an orderly way, says Bosworth, “and frankly, some financial relief from the current situation that they’ve gotten into.”
“The question is, who pays?” asks Brad McMillan, chief investment officer for the Commonwealth Financial Network, a wealth management company.
Debt holders in the U.S. could be on the hook, including many Americans who may not realize that they hold Puerto Rican debt in their mutual-fund portfolios. It is very likely that debt holders will eventually have to take a write-down on some of the debt, or renegotiate interest rate terms that are more favorable to Puerto Rico, Bosworth says.
“So there can be a solution that works for Puerto Rico, in writing off some of the debt … and also works for the investors as a whole,” he says.