Bankruptcy Contagion: Today, Puerto Rico… Tomorrow, Illinois

A nun walks in front of a closed furniture store in Lares, Puerto Rico, on September 2, 2015.
AP/Ricardo Arduengo

The financial situation in Puerto Rico is at a crisis point, leading to proposals for a massive bailout that would ostensibly stabilize the island’s economy and protect small investors… but would, in fact, be a tremendous giveaway to Wall Street interests.

It’s a story people should be following across the nation, because it has ramifications for the 2016 election. In fact, Puerto Rico might have already decided the presidential race.

The presidential political angle is simple: thousands of Puerto Ricans have been flowing into Florida, particularly the “I-4 corridor” between Tampa and Orlando. They’re generally Left-leaning voters, and they have an exceptionally high rate of voter participation – voter turnout of eighty percent is not unheard-of in Puerto Rican elections.

A new report about how Puerto Ricans are changing Florida seems to pop up every month in the media. An article in Yahoo News last year floated the idea that the recent wave of arrivals might be reachable by Republicans, but this assertion seems largely on the “sizable number of doctors, nurses, teachers, engineers, lawyers, managers and professors” bailing out of Puerto Rico in its hour of crisis, and the assumption they might vote GOP because they’re career-oriented and live in upscale neighborhoods.

A September 2015 post from Fox News Latino found both Republican and Democrat teams working Puerto Rican events in Florida, battling for a share of the million-strong population, with a thousand new arrivals pouring into Central Florida every week. They voted for Barack Obama by an overwhelming margin in 2012.

While we wait to see if that hypothesis about latent conservative leanings in the upper-middle-class Puerto Rican contingent pans out, available evidence suggests that a continued exodus from the island could decisively tip Florida to the Democrats for a generation, effectively ending Republican hopes of winning the White House.

The major reason for the great Puerto Rican relocation is the island’s awful economy, with 12 percent unemployment, 40 percent workforce participation, a 5 percent loss in population over the past five years, and a staggering debt burden of $72 billion. Debt relief has become the dominant topic of mainland political discussion with respect to Puerto Rico, whose situation is often compared to the relationship between Greece and its European Union creditors.

Puerto Rico is presently forbidden from pursuing bankruptcy, as a municipal government within the continental United States might. As the New York Times reports, the Obama Administration is asking Congress to give Puerto Rico a special “territorial bankruptcy regime,” coupled with a rather nebulous form of fiscal oversight. Other measures in the proposal include granting the Earned Income Tax Credit to Puerto Ricans – a system that would pay refunds even to people who don’t pay any taxes – and an infusion of money into the Medicaid program.

The island’s creditors fear that any such arrangement could leave them with pennies on the dollar, and accuse the island’s government – dogged by persistent allegations of corruption – of “portraying its financial situation as beyond repair, hoping to force the administration and Congress to give it access to Chapter 9 bankruptcy.”

Another concern about bailing out Puerto Rico, or giving it access to bankruptcy courts, is that basket-case states like Illinois could demand equivalent considerations. The bankruptcy contagion is likely to spread quickly, even with nominal protections such as the insistence that Puerto Rico and other territories enjoy a special form of bankruptcy protection unavailable to mainland states.

The Senate Republican counter-proposal, as described by CNBC, includes “up to $3 billion in cash relief, a payroll tax break for residents of the island and a new independent authority that could borrow for Puerto Rico – but with no taxpayer guarantee.” The cash relief would be drawn from uncommitted funds currently languishing in a massive ObamaCare slush fund.

The Republican plan offers Puerto Rican workers a 50 percent cut in Social Security taxes, the sort of “job-creating tax cut” idea politicians are in love with, because it benefits employees directly, even though it never seems to produce the sort of job growth that was promised. (The real drawbacks to Puerto Rican job creation are absurdly high mandatory costs, including European-style vacation policies, plus an insane regulatory burden confronting almost every business enterprise, especially start-ups that could threaten well-protected established interests.)

There is also an interesting provision to require both Puerto Rico and all of the state to stop using actuarial calculations for pension liability, which tends to dramatically understate the true size of government debt. (Readers may be familiar with the general concept of switching to “fair-value numbers” from the arguments that the U.S. federal government’s debt is vastly higher than the $18 trillion commonly reported – maybe over ten times higher.) CNBC suggests this sort of financial disclosure would “make it easier to identify other states whose pension systems are so distressed that they may have to try similar negotiations in the future.”

It’s probably easier to identify the states whose pension systems are not in distress.

The Puerto Rican situation highlights an insidious aspect of Big Government bloat: those massive public-employee benefit funds depend on constant infusions of cash from current workers, to cover the cost of retiree benefits. Downsize the government significantly, laying off a sizable number of government workers, and public-employee pensions detonate like booby-trap bombs going off – fewer workers paying into the system quickly produce crisis-level deficits. It’s a kind of fiscal voodoo that means reducing the size and cost of government can actually increase the deficit.

The Senate Republican plan has a stronger “control board” for taking charge of Puerto Rico’s finances than the Obama proposal, installing a manager who would remain in place for five years to impose fiscal discipline. An even stronger control might be in order, because the lesson of governments crushed by debt is that they can never muster the political will to reform themselves.

Senator Orrin Hatch (R-UT) of the Finance Committee complained that Congress has been “unable to receive audited financial statements from Puerto Rico, or adequate information from federal health officials” to “clarify how the interplay between federal tax, health care, and pension policies affect the territory’s economy.”

Puerto Rico is yet another disaster of central planning, with an economy paralyzed by hyper-regulation, a treasury looted by crony corruption, and unsustainable debts accumulated through long years of easy credit that should never have been extended to it.

Socialist benefits have degraded its human capital, but there is no willpower to cut back on benefit spending… and now the best of its workers are looking for a better life in Florida, making the situation for those who remain on the island that much worse. The demographics of an aging population are reducing the ratio of workers to retirees, as is occurring in much of the Western world.

Among those crying foul over Puerto Rican debt sales is Arizona Rep. Raul Grijalva (D-AZ), who called for congressional hearings into the role of hedge funds in the debt crisis at the end of September. As Bloomberg Business reported, Grijalva’s staff produced a report “asserting that some hedge fund managers are trying to affect the outcome of the crisis to pad profits rather than accept losses from investment miscalculations.”

On the Republican side of the aisle, Rep. Sean Duffy (R-WI) has introduced a bill called the Puerto Rico Financial Stability and Debt Restructuring Choice Act, which would give Puerto Rico “access the same chapter 9 bankruptcy process that America’s States do, if it also agrees to an independent Financial Stability Council to oversee the island’s path toward balanced budgets and a return to financial stability.”

Duffy’s goal is to combine the debt restructuring Puerto Rico desires with large-scale changes to the way it “manages its budgets, tax collection, and finances.” Everyone seems to agree there should be no taxpayer “bailout” of Puerto Rico, but the definition of “bailout” is fluid, and the level of outside fiscal control the island government must accept in exchange for some form of bankruptcy protection is a matter of much debate.

Not only is it necessary to get a handle on the Puerto Rican crisis, it is also vital to prevent the incubation of a bankruptcy contagion that could spread rapidly to states across the continent, which could in turn trigger an apocalyptic federal debt crisis.  We also don’t want to send the message that the best way to extract concessions from Washington is to create a fiscal and political disaster so huge that it cannot be ignored.

As with every other indebted government facing impossible choices around the world, easy debt helped Puerto Rico put off hard choices until they became impossible choices. Easy debt conceals the true cost of government, causing madcap regulatory states to seem like a luxury the population can afford, and fueling the creation of entitlements that become irresistible political forces over the course of generations. When a debt becomes literally impossible to pay off, as with Puerto Rico, that debt begins mutating into something different than a pure obligation. It becomes a politically explosive mixture of liability and leverage.

We have to do something about Puerto Rico, and soon.

Unfortunately, those who insist on effective fiscal restraint are likely to find themselves denounced as “austerity” tyrants… while Puerto Rican politicians can look at those Florida numbers and conclude they might not have enough money to pay their debts, but they have a steadily accumulating balance of political clout.


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