Three of the fundamental premises established in my essay published eight months ago under the title «Toward the Economic Refounding of Puerto Rico and its Commonwealth Status» were: that there was a real risk of the Island not being able to pay its debts; that the United States had to be part of the solution; and that the economic and public debt situation, as well as its solution, is intimately related to the issue of the political status or relationship with the USA.
Today there is a general consensus in regards to the possibility that at least one of the government’s public corporations could default, as well as widespread calls for some kind of debt restructuring. Although there has been no action from the federal government, there have been strong calls for some type of intervention or assistance, and Resident Commissioner Pedro Pierluisi has even filed a bill, with the total support of the Government of Puerto Rico, to allow Chapter 9 of the Federal Bankruptcy Act to be applied to Puerto Rican instrumentalities, the same way it is available in the states.
In this blog I’m not going to restate my proposed solutions. You can read the book. Rather, I will stress that the United States government has to be part of the solution, and will demonstrate that there is a high possibility that the U.S. is also responsible for the payment of the debt. That is the reason I’m writing this in English, although I will also have it available in Spanish.
YES YOU SHOULD
Puerto Rico is confronting two crises simultaneously: the greatest economic downturn of our modern history and an overwhelming government debt burden. The combination of the elimination by the U.S. Congress back in 1996 of section 936 of the Internal Revenue Code, with its dire economic consequences and adversarial effect on the structural deficit of the government of Puerto Rico and its major public corporations, and a ballooning debt service in the coming years has yielded the perfect storm. The fiscal crisis worsens the economic crisis, and this in turn affects the former. It is a vicious cycle in which the feasible measures of economic stimulus exacerbate the fiscal crisis and the attention to the fiscal crisis has negative effects on our economy.To top it off, for the first time in our history our population is shrinking. Strong actions and assistance are needed to provide the space for our economy to grow so that we can ultimately pay the debt.
Although Puerto Rico bears a great part of the blame, the United States is also responsible for the economic crisis. It’s not only the elimination of Section 936 in the 90’s, without giving Puerto Rico any power or tool to compensate for that loss. It’s also that the indiscriminate application of federal laws to Puerto Rico has the effect of imposing variables and standards of the most economically developed country in the world, while the Puerto Rican economy has never attained full development, making Puerto Rico less competitive in the world economy. Even the most recent report of the Federal Reserve Bank of New York (July 2014), specifically mentions as elements that hinder our economic growth the application to the Island of the federal minimum wage and the Jones Act (cabotage law), which are both clear examples of economic variables beyond our control. Additionally, the Chairman of the House of Representatives Natural Resources Committee, Congressman Rob Bishop, has publicly expressed concerns about the negative economic impact that the application of certain EPA rules, especially regarding our high cost of energy and the need to move toward more natural gas.
With regard to the famous (or infamous) $72 billion debt, we need to remember that all that debt was originally incurred when Puerto Rico had a positive credit rating by the American credit agencies, and was all originally sold in the strongly regulated federal municipal bond market. Yes, the Government of Puerto Rico was asking to borrow too much. But excessive lending and borrowing was possible, because that was the monetary policy of the U.S. The years in which the amount of money being borrowed exploded, was during the time the Federal Reserve Bank carried out its expansive monetary policy with near zero interest rates. To that same extent, the crisis of the banking system in the U.S., which almost collapsed in 2008, had a similar origin. The «real estate bubble» was possible because the Feds were allowing easy money into the system. Lenders with access to free money at near zero interest went crazy providing mortgages to people they knew had little chance of paying it back. In part, that is precisely why the federal government bailed out the financial sector. The banks were responsible for their mismanagement and the homeowners for biting the bait, but the Feds were accomplices in that failure. In our case, if we were incurring too much debt, it was in part because the Feds kept the interest rates artificially low, which in turn opened the appetite in Wall Street for higher yielding bonds from Puerto Rico, all under the watchful eyes of the various federal credit rating agencies.
Crucially, if the United States were undergoing a crisis similar to the one Puerto Rico has on its hands, they would take immediate measures that Puerto Rico cannot take. The first one being: go and print more money. The second one: borrow unlimited amounts of money to stimulate the economy, and use its Central Bank (the Federal Reserve Bank), to establish a monetary policy to foster economic development.
Puerto Rico has none of those tools. Even in Europe, with its common market and Euro Zone, the European Central Bank continuously acts to react to the different needs of its country members. And on top of that, Puerto Rico’s cities and towns, as well as its public corporations, cannot use the mechanism of the Federal Bankruptcy Code, like Detroit recently did. As a friend recently told me, a year ago we were being compared to Detroit and Greece and our intuitive reaction was «no way.» A year later we are starting to say: «we hope we are Detroit and Greece. At least one could get protection from the court and the other had a central bank who intervened» Detroit is coming out of bankruptcy by restructuring it debts using the federal law we cannot use, and Greece at least has a central European bank to fight with. We have no one.
But if these arguments were not enough, the United States needs to understand that our crisis will have consequences for them in the mainland as well. If Puerto Rico or any of its public corporations fail to meet their debt payments to bondholders, this, besides affecting the Island’s economy even further, will have an indeterminate effect on the municipal bond market in the United States. And if our economy continues to stagnate, one of two things will happen, or maybe both: (1) the levels of dependence on federal transfers will increase dramatically in order to maintain a minimum level of quality of life, and (2) to the extent that there is not enough money to sustain the levels of government services that the population requires, the more dependent and less productive sectors will choose to emigrate to the United States. In simple words, if Puerto Rico fails, the U.S. Treasury eventually will take the tab.
And, I may add, the most recent development: the world is watching. Every day, more international news outlets are looking into the Puerto Rico situation. And the more they see, the more they point to the Unites States’ shared responsibility in this crisis. If Puerto Rico fails, it could easily become a negative international issue for the United States. Bear in mind that for Latin America and the Caribbean, Puerto Rico is a sister country. What happens in Puerto Rico does not stay in Puerto Rico and the U.S.
YES YOU CAN
If the United States should be part of the solution, the question remains, can they do it? The answer is yes. Through the Treasury Department and the Federal Reserve Bank, the Executive Branch has broad powers and mechanisms to alleviate the debt crisis. There are many academic and economic studies out there, some public, other private, that demonstrate that those federal agencies do not need any congressional approval in order to act regarding Puerto Rico. It is a matter of will.
But Congress also has its share of the responsibility. Resident Commissioner Pierluisi’s bill is a step in the right direction. But it is not enough. If we want real and sustainable economic development and to limit the dependency on federal transfers and incentives, what Congress needs to do is give Puerto Rico the power to legislate in economic matters, the same way we do today, and have done for more than a hundred years regarding our tax system, without intervention from Congress. That is why I’m convinced the permanent solution is tied to the status issue. The solution, which I describe in more detail in my August essay, is what has been called the Sovereign Commonwealth. But I will not elaborate more on that in this piece.
To the argument that the U.S. Government will not act because they don’t want to established a «precedent,» my answer is very simple: there will be no precedent, because we are not and do not want to become a state. The participation of the U.S. in the solution has to be based on the special political relationship between the United States and Puerto Rico, and as such will not be a precedent for the fifty states.
IT IS ALSO YOUR DEBT
Finally, the United States has to be part of the solution, because at the end of the day, the U.S. Supreme Court might decide that the U.S. Government is responsible for Puerto Rico’s debt. And yes, on this we will hit the status issue head-on. It is inevitable.
First, let’s understand how that debt was incurred. Puerto Rican bonds are regulated by Federal law. In 1917, as part of the Jones Act that established the government structure for Puerto Rico, Congress authorized Puerto Rico to issued bonds, and included a provision exempting all bonds issued by the Government of Puerto Rico from state and federal taxation. Section 745 of title 48 of the United States Code provides:
«All bonds issued by the Government of Puerto Rico, or by its authority, shall be exempt from taxation by the Government of the United States, or by the Government of Puerto Rico or of any political or municipal subdivision thereof, or by any State, Territory, or possession, or by any county, municipality, or other municipal subdivision of any State, Territory, or possession of the United States, or by the District of Columbia.»
Our bonds have been marketed based on a federal law, playing by the federal rules. This provision was adopted in 1917 as part of the plenary powers of Congress over the territory of Puerto Rico. Congress ordered the other states not to tax ours bonds, something that clearly Congress has no power to do with regards to specific state bonds. For the last 25 years or more, the official position of the United States Department of Justice, the House and Senate Committees with jurisdiction over Puerto Rico and the White House reports of both Presidents George W. Bush and Barack Obama have established that even after the establishment of the Commonwealth of Puerto Rico in 1952, Puerto Rico is still a non incorporated territory. The most recent report from the White House specifically states: «under Commonwealth option, Puerto Rico would remain, as it is today, subject to the Territory Clause of the U.S. Constitution» (March 2011). Therefore, it could be argued that the powers that Congress had to establish in 1917 section 745 granting triple tax exemption to our bonds are the same powers they have today to keep that exemption and impose it upon the fifty states. All this legal and financial history is a clear indication that the U.S. government has a shared responsibility over our debt. But there is more. In January 8, 2007, the United States Supreme Court ruled on the case of Limtiaco, Attorney General of Guam v. Camacho, Governor of Guam. The issues are quite particular, but the rationale of the decision is very interesting. There was a «local» dispute between the Governor of Guam and his Attorney General regarding a bond issuance and whether it was an infringement of a debt limitation disposition included in the federal Organic Act of Guam. The Governor of Guam sought a declaration from the Guam Supreme Court that the issuance of bonds to fund the territory’s continuing obligations, authorized by Guam’s legislature, was not in violation of debt limitation disposition contained in the Organic Act of Guam, contrary to the contention of Guam’s Attorney General. The Guam Supreme Court agreed with the Governor. The United States Court of Appeals for the Ninth Circuit dismissed the attorney general’s appeal. The United States Supreme Court reversed. It is the last paragraph of the Court’s opinion, written by Justice Thomas, that brings some light to the federal government’s responsibility in regards to the debt of a territory:
«It may be true that we accord deference to territorial courts over matters of purely local concern. This case does not fit that model, however. The debt-limitation provision protects both Guamanians and the United States from the potential consequences of territorial insolvency. Thus, this case is not a matter of purely local concern.»
It is true that in that case the Supreme Court was interpreting a federal law that establishes the Government of Guam. In our case, the Government of Puerto Rico is ruled by our own constitution that was authorized and approved by Congress and the people of Puerto Rico. But that does not change the rationale of that paragraph: the United States will bear responsibility for the financial insolvency of a territory, and the issues related to territorial bonds are a matter of national concern.For many years during my political life I have argued against the definition of Commonwealth as a territory. Nevertheless, the official position of the United States is that we are still a territory. If that is the case, taken together with cited section 745, there is a strong argument that the United States might bear «the potential consequences» of Puerto Rico’s insolvency and that the $72 billion debt «is not a matter of purely local concern.» The federal government cannot say that we «remain, as it is today, subject to the Territory Clause of the U.S. Constitution» in order to deny Puerto Rico the powers to solve our economic and social crisis, and now turn around and say that they have no responsibility regarding our debt because the debt crisis is a «a matter of purely local concern.» You cannot have your cake and eat it too.
So, I have news for the United States. If Puerto Rico were to default on any of its payments, any of those bondholders affected might take the Government of the United States to court. And Limtiaco v. Camacho seems to say that they have potential for a solid case. I firmly believe that the United States has to be a part of the solution to Puerto Rico’s economic and debt crises. I believe so, not as a legal argument, but because it is the right and fair thing to do for Puerto Rico and for the United States. But at the end of the day, it might be the legal responsibility that will move the U.S to action. In the last 18 months I have heard the argument that the U.S. will not act regarding Puerto Rico because «it is too small to save.» That could be true. But maybe the other part of the equation is also true: «Puerto Rico is too big to fail.» Yes, Puerto Rico: too small to save, too big to fail.