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What’s going on with Puerto Rico’s debt issue?

puerto rican flag on a sunny day
August 07, 2015

By Alissa Green

Why has Puerto Rico been in the news so much of late? It defaulted on its debt, big time. Will it affect you?

Background info on Puerto Rico:

If Puerto Rico were dating the United States, its relationship status would be the following: It’s complicated.

Technically, the island of Puerto Rico is a Commonwealth of the United States, but it doesn’t have voting power in either the U.S. House or the U.S. Senate, even though both have ruling power over Puerto Rico.

Said another way, Puerto Rico enjoys most state benefits of the United States – but can’t vote and is exempt from certain taxes. Oh, and it’s also unable to file Chapter 9 of U.S. Bankruptcy law (more on that in a minute).

The current situation in PR:

Puerto Rico has been experiencing a growing economic crisis for some time and for many reasons (including its ambiguous relationship with the U.S.). However, last month, Puerto Rican Governor Alejandro García Padilla escalated the situation by saying that the island’s debt of $72 billion was “not payable.”

Standing behind his words, this week Puerto Rico missed paying an important bond payment. Just how badly did Puerto Rico miss its payment? It paid only $628,000 of the $58 million it owes. Compared to the U.S. national debt of $17 trillion, that’s pretty small. Even California and New York have amassed more debt than the amount PR owes. But for a small island with a wavering economy? Not good.

Puerto Rico is hoping that the U.S. Congress will consider Puerto Rico more like a U.S. State– and pass legislation to help Puerto Rico get its debt resolved under U.S. bankruptcy laws. While many Americans live in insolvent states (Hi, Illinois), no state has actually defaulted on its bond payments since Arkansas defaulted in 1933 during the Great Depression.

Potential outcome for Puerto Rico:

As you can probably guess, the potential outcome for this troubled island doesn’t look great. When any person (or entity) borrows money and doesn’t pay it back, its credit rating sinks -- making it incredibly expensive to borrow additional money.

“One of the biggest issues for Puerto Rico is that under its own constitution, it can’t declare bankruptcy,” says John Macdonald, Assistant Portfolio Manager at Alliant. “Puerto Rico recently tried to pass legislation to let its public corporations do so – and that was ruled unconstitutional. So, now it’s looking at the U.S. bankruptcy code for its public agencies.”

When American cities are in trouble, like, say, Detroit in 2013, they’re able to take advantage of this last ditch effort. But Puerto Rico has no similar protection, meaning that the Puerto Rican government will have to negotiate with its creditors independently. Puerto Rico has tried introducing legislation in Congress that would let its take advantage of U.S. bankruptcy law, but so far those efforts haven’t gotten traction.

Currently, it looks like Puerto Rico’s best options are a:

  • U.S. bailout (which is not likely at this point).
  • U.S. bankruptcy protection for public agencies (PR currently doesn’t qualify and needs legislation to pass for this to be an option).
  • Default, which would mean making a deal with creditors to reduce or restructure debt.

How the Puerto Rico debt issue affects you:

“If you don’t live in Puerto Rico, the impact on consumers is fairly indirect at this point,” says Macdonald. “The main issue here is the devaluation of existing positions and uncertainty that investors now feel regarding any holdings in Puerto Rican bonds. Large amounts of Puerto Rican debt are held in the mainland U.S. So, while these issues are not catastrophic, they are definitely very real for many investors.”

It’s also looking more and more like the future of Puerto Rico will become a core issue in the upcoming U.S. Presidential Race. Why? Because nearly five million voters of Puerto Rican descent live in the U.S., many of them in Florida. According to Puerto Rico Secretary of State Kenneth McClintock (as told to Mother Jones in July), "Puerto Ricans are the swing voters in the swing region of a swing state."

Two interesting PR facts:

  • Spain ceded Puerto Rico to the United States after the Spanish-American War ended in 1898, as part of the Treaty of Paris.
  • The majority of PR bonds are exempt from state, federal and local income tax (which is why so many Americans have Puerto Rican bonds).