Puerto Rico: An Island In Decline
These days, Puerto Rico just never seems to catch a break from the worst that fate has to throw at it. From Hurricane Maria's devastating physical and economic impact in 2017 to the island's deteriorating debt situation, Puerto Rico’s dire circumstances are the story of negligent administration, both at the territorial and federal levels of government. Sadly, despite the general recovery from the COVID-19 pandemic, Puerto Rico’s economic status does not seem to be improving considerably.
Economic downturns most brutally impact those areas in the world that had already experienced financial hardship. It is a tragedy that Puerto Rico is no different. Arguably, Puerto Rico bears the most negative impact from recessions. For example, during the Great Recession, which lasted approximately from 2008 until 2009, Puerto Rico was faced with a worsening debt crisis. It quickly became dependent on financial institutions, based in the mainland of the United States, to alleviate its debt burden. While that may seem as an expression of generosity, it is vitally important to remember that these institutions were creditors of Puerto Rico, not grantors. Thus, in this way, and in many others, the Great Recession truly ends at different times in different places, and sadly, Puerto Rico is a place where that crisis never truly ended.
Though Puerto Rico’s fiscal problems truly began with the economic crisis caused by the 1973 Arab oil embargo, the Puerto Rican government largely shielded itself from financial fallout by issuing bonds and encouraging investment from the American mainland and from other countries. These and other policies yielded returns large enough to prevent debt from moving out of control. For example, according to the Congressional Research Service, in the period 1973-1994, total public debt remained almost constant, at around $20 billion, in 2017 terms. Since 1994, however, Puerto Rico’s debt burden has been increasing rapidly, with a decline only beginning in 2014, while being significantly above pre-1994 levels.
The situation had become especially damaging in 2006. At that time, Merrill Lynch, a very powerful, Wall Street-based investment firm, stepped in as one of many financial advisors to the territorial government of Puerto Rico, according to the Federation of American Scientists. Specifically, the firm advised Puerto Rican fiscal officials to issue $7 billion of securities known as Pension Obligation Bonds. A Pension Obligation Bond is a bond issued by the Puerto Rico Employee Retirement System allows a purchaser to earn money after paying a fee set by the issuer. Purchasers usually consist of large businesses but may also be individuals or any other organization. In these transactions, the purchaser is intended to receive the full value of the initial payment, along with a percentage of that payment, called interest. When they were being issued in 2006, Merrill Lynch believed that investors would buy the bonds because they expected that the earnings from bond issuance to be high, both for the investors and for the Puerto Rican government. However, Merrill Lynch did not take into account the high cost of borrowing for the investors, resulting in investors refusing to purchase the bonds due to the lack of exemption from federal taxation. Investors have long grown accustomed to tax exemption at all levels of government, especially the federal level, because of laws such as Sections 103 and 148 of the Internal Revenue Code, passed in the Tax Reform Act of 1986 as amendments to the Internal Revenue Code, exempting interest from state and local bonds from federal taxation.
With debt levels soaring in Puerto Rico, local governments used the same strategy of issuing pension obligation bonds to pay past debts, and while they were able to secure funding from investors, it was not enough to pay pension fund liabilities due to the fact that proceeds from bonds went to other debts and investors demanded higher interest. Thus, pension liabilities, as well as general liabilities, sharply increased in 2006 and continued to do so into the future. According to the Congressional Research Service, another financial institution, Union Bank of Switzerland, was also involved in a restructuring of Puerto Rico’s debt. However, unlike Merrill Lynch, who played a mainly advisory role in the debt restructuring, Union Bank of Switzerland employed direct measures with respect to Puerto Rico’s public debt in 2008. According to the Congressional Research Service, the bank underwrote three rounds of pension obligation bonds. Through this mechanism, Union Bank of Switzerland sold the bonds to Santander, Banco Popular, and mutual fund companies. However, these bonds brought with them losses, rather than gains, and as a result, Union Bank of Switzerland was required to pay $34 million to settle claims with the U.S. government in 2015.
Puerto Rico’s debt, across all categories, would continue to increase from 2013-2017. In that period, the territorial government increasingly, though fruitlessly, relied upon bond issuance to counteract its recession. Although the Federal Oversight Management Board for Puerto Rico was created in 2016 to assist Puerto Rico in designing budgets to counteract its debt problem, the combined effects of financial damage caused by Hurricanes Irma and Maria in 2017 were only compounded by continuous disputes both within the Puerto Rican government as well as with bondholders and the U.S. government under Title III of the Puerto Rican Oversight, Management, and Economic Stability Act of 2016, known as PROMESA. PROMESA was a law passed under the administration of former U.S. president, Barack Obama, in 2016. This law created the Federal Oversight Management Board (FOMB), an agency designed to ensure that Puerto Rico's government was taking steps to reduce its debt. However, under Title III of PROMESA, Puerto Rico was mandated to allow the FOMB to act as a party in cases relating to debts owed by Puerto Rico, resulting in Puerto Rico being obligated to pay its plaintiffs. These circumstances hindered economic growth. Because PROMESA is still in effect, Puerto Rico does not have much control over its finances. These conditions left Puerto Rico less prepared to respond to the earthquake in 2020. However, in 2021, according to Bloomberg Magazine, Puerto Rico received direct federal funding, which did play a role in stimulating industries like manufacturing and tourism, especially in response to the COVID-19 pandemic. Still, the recovery remains fragile, with federal funding as well as debt issuance continuing to serve as revenue mechanisms.'
In short, lack of cooperation and coordination between the Puerto Rican territorial government, the U.S. government, and many private and public sector entities, is the cause of Puerto Rico’s economic woes. Unfortunately, from time to time, both private and public sector continued insistence that Puerto Rico issue bonds, sometimes without properly assessing the risks and challenges involved, have left the island in a weaker state to confront both financial and societal problems, such as loss of infrastructure from natural disasters. With recoveries lasting for very brief periods of time, it is uncertain as to whether Puerto Rico’s economy will reach pre-1973 levels of debt and economic prosperity. Unless this occurs, ordinary people will be impacted heavily by the shocks to the economy.
Works Cited
Congressional Research Service. (2021, May 18). Puerto Rico’s Public Debts: Accumulation and Restructuring. Federation of American Scientists. https://sgp.fas.org/crs/row/R46788.pdf.
Puerto Rico Management, Stability, and Oversight Act of 2016, 48 U.S.C. §2101 et seq. (2016). https://uscode.house.gov/view.xhtml?req=granuleid%3AUSC-prelim-title48-chapter20&saved=%7CZ3JhbnVsZWlkOlVTQy1wcmVsaW0tdGl0bGU0OC1zZWN0aW9uMjEwMQ%3D%3D%7C%7C%7C0%7Cfalse%7Cprelim&edition=prelim
Tax Reform Act of 1986, 26 U.S.C. §103. (1986). https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section103&num=0&edition=prelim
Tax Reform Act of 1986, 26 U.S.C. §148. (1986). https://uscode.house.gov/view.xhtml?req=(title:26%20section:148%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section148)&f=treesort&edition=prelim&num=0&jumpTo=true
Wyss, J. (2022, January 20). Puerto Rico Bankruptcy is Ending. Next Step: Grow Its Economy. Bloomberg. https://www.bloomberg.com/news/articles/2022-01-20/puertorico-bankruptcy-is-ending-next-step-grow-its-econom
