Puerto Rico, as it stands, is currently facing a $72 billion debt. The island, a commonwealth of the United States, has bitten more than it can chew and is struggling to pay back its debt to its creditors. Puerto Rico is expected to default on its $422 million debt payment on May 1st, if Congress cannot come up with a solution to the island’s financial problem.
The problem stems from Puerto Rico borrowing money in the face hard economic times. In an effort to stabilize its budget and restructure its debt, Puerto Rico sold $3.5 billion worth of its obligation bonds. These bonds would be considered a top priority for Puerto Rico, according to its constitution. These bonds would be paid before the island would pay its other municipal debt such as hospitals, law enforcement agencies or educational department.
Even more mind boggling, Puerto Rico is exempt from filing for Chapter 9 Bankruptcy. Chapter 9 bankruptcy offers the municipalities of a state protection from its creditors by restructuring its debt by negotiating and adjusting the state’s commitment to creditors. Since 1933, Chapter 9 Bankruptcy had applied to the commonwealth island until James Strom Thurman, a Republican Senator from South Carolina, proposed a provision that would exempt Puerto Rico from filing for Chapter 9 in 1984. The Provision was part of the Bankruptcy Amendments and Federal Judgeship Act of 1984. However, there was never any historical context given as to why the island, a commonwealth of the United States, was exempt from filing for bankruptcy.
Because of its exemption from Chapter 9, Puerto Rico is essentially beholden to its creditors. These creditors are largely made up of hedge fund groups such as Oppenheimer Funds, who’s Rochester Maryland Municipal Fund Holdings is made up of 50.4 percent of Puerto Rico’s bonds, which generally benefits from situations similar to this one. These debts are referred to as “vulture debts” and currently makeup 30 percent of Puerto Rico’s creditors.
The bonds that were initially issued to investors were bought yielding some 8.73 percent interest rates. While it was surprising that investors were willing to purchase bonds yielding that much rather than a 10 percent demand, experts say the bonds were still double of what municipal bonds typically will go for.
Another amazing feature of the bonds were the triple exemption they came with. In other words, in an effort to make these bonds more attractive, the bonds that were purchased were ultimately exempt from federal, state and local taxation. This would become one source of revenue Puerto Rico could not depend on.
Some Puerto Rican bondholders that can be hurt by the default are individuals who were sold the bonds under questionable circumstances. The bonds were underwritten by the investment bank UBS, which later sold bonds to itself through a subsidiary, had sought to off load the bonds to Puerto Rican customers. In fact, the sales division within the bank had drafted 22 reasons as to why the bank should abstain from promoting and ultimately selling the bonds. UBS has says it has done wrong, which is technically true.
Typically, it is illegal for an investment bank to knowingly sell toxic bonds to consumers as per the Investment Act of 1940. However, much like Chapter 9’s Bankruptcy provision, Puerto Rico is exempted from the Investment Act. Because of this provision, UBS will not have to face any liabilities or consequences.
Puerto Rico’s $70 million debt isn’t just exclusive to its bonds debacle. There are other variables in effect that add to the island’s financial struggles.
During the 1970s, in an effort to keep businesses from going overseas, Congress sought to promote businesses relocating to the commonwealth of Puerto Rico. They did this by offering tax exemptions for companies that moved operations to the island. This worked out great for Puerto Rico as many manufacturing firms began to open across the island. Among those firms were 89 pharmaceuticals that operated out of Puerto Rico including Pfizer, which manufactured Viagra out of the Barceloneta section of Puerto Rico.
However, in 2006, Congress began to phase out the tax breaks for companies operating in Puerto Rico to offset the tax breaks back on the mainland. The result was the loss of half of the manufacturing jobs in Puerto Rico as well as the migration of half of a million of its citizens, which headed to the states in search of work.
Puerto Rico has tried to attract wealthy individuals and small businesses by allowing making capital gains tax exempt. The purpose was to create 50,000 jobs but the result was only 12 percent of the goal, creating 5,832 jobs. Unemployment currently remains in the double digits.
Senate majority leader Paul Ryan has promised at the beginning of the year to make the Puerto Rico financial crisis a top priority. Congress has made bipartisan efforts to help resolve the issue by trying to draft a resolution that would restructure the island’s debt. This by no means is a bailout for Puerto Rico but the option is not off the table.
Recently, commercial ads for a dark money special interest group called the Center for Individual Freedom have been playing in Washington and the districts of various congress members, calling for constituents to call their congressmen and tell them not to vote for a bailout for Puerto Rico, despite the fact that no such bailout has been proposed. Experts suspect that hedge fund groups that are looking to maximize their earnings from the islands bonds are funding the $2 million dollar ad.
Members of congress, however, are adamant about resolving the financial issue Puerto Rico is facing before it heads off of a fiscal cliff.
Puerto Rico’s financial crisis would affect America in a way not even Detroit has been able to. Its debt is bigger than every state in the country except New York and California. Its economy is said to be as small as that of Oklahoma. Now with the Zika virus outbreak that affects Puerto Rico on a large scale, tourism is expected to drastically decline.
Needless to say, Congress must act sooner than later. Why wait until the 11th hour? The commonwealth island is in dire need of help.
