The Puerto Rican government-debt crisis was a financial crisis affecting the government of Puerto Rico. The crisis began in 2014 when three major credit agencies downgraded several bond issues by Puerto Rico to "junk status" after the government was unable to demonstrate that it could pay its debt. The downgrades, in turn, prevented the government from selling more bonds in the open market. Unable to obtain the funding to cover its budget imbalance, the government began using its savings to pay its debt while warning that those savings would eventually be exhausted. To prevent such a scenario, the United States Congress enacted a law known as PROMESA, which appointed an oversight board with ultimate control over the Commonwealth's budget. As the PROMESA board began to exert that control, the Puerto Rican government sought to increase revenues and reduce its expenses by increasing taxes while curtailing public services and reducing government pensions. These measures provoked social distrust and unrest, further compounding the crisis. In August 2018, a debt investigation report of the Financial Oversight and management board for Puerto Rico reported the Commonwealth had $74 billion in bond debt and $49 billion in unfunded pension liabilities as of May 2017. Puerto Rico officially exited bankruptcy on March 15, 2022.
Background
Puerto Rico is a territory of the United States, acquired in 1898 through the Spanish–American War. Unlike U.S. states it has no sovereignty, and all of its powers are delegated from the United States Congress under the Territorial Clause of the federal constitution. It has had an elected governor since 1948, and elected legislature since 1900.
While primarily service based, Puerto Rico also has a strong manufacturing sector, with pharmaceuticals and electronics leading the way. The services sector, including finance, real estate, and tourism, is a crutial contributor to Puerto Rico’s GDP. Its unique geographic location boosts its tourism sector from its tropical climate and cultural heritage. Puerto Rico’s trade is heavily reliant on the U.S., and being a territory, most exports are directed toward U.S. markets as well as imports, which benefits from the territory’s duty free access. Manufacturing, particularly pharmaceutical and electronics, also play a vital role in the islands GDP, with Puerto Rico being one of the largest pharmaceutical production hubs in the world. Agriculture, though smaller, provides exports such as coffee, sugarcane, and tropical fruits. The economic framework of the island is a consequence of its dependency on U.S. commercial and regulatory systems. However, Puerto Rico’s economy faces challenges such as high public debt, dependence on U.S. fiscal policies, and the features of its geopolitcal location containing many natural disasters.
In 1984, Congress explicitly forbade Puerto Rico from declaring bankruptcy under Chapter 9, Title 11, United States Code. Between 1996 and 2006, Congress eliminated the tax credits, contributing to the loss of 80,000 jobs on the island and causing its population to shrink and its economy to contract in all but one year since the Great Recession. Because the Constitution of Puerto Rico established that "all available resources" must first go towards payment of the Commonwealth's general obligation bonds, in 2006, the Commonwealth began issuing Puerto Rico Sales Tax Revenue Bonds, to avoid its constitution's limits by being paid directly into a separate urgent interest fund. Sales tax was increased to 11%. The last property tax assessment was done in 1958. It was not until Puerto Rico enlarged its outstanding debt to $71 billion—an amount approximately equal to 68% of Puerto Rico's gross domestic product (GDP)—that Puerto Rican bonds were downgraded to non-investment grade (better known as "junk status" or speculative-grade) by three bond credit rating agencies between February 4 and 11, 2014. This downgrade triggered bond acceleration clauses that required Puerto Rico to repay certain debt instruments within months rather than years. Investors were concerned that Puerto Rico would eventually default on its debt. Such a default would reduce Puerto Rico's ability to issue bonds in the future. Puerto Rico currently states that it is unable to maintain its current operations unless it takes drastic measures that may lead to civil unrest. There have already been protests over the austerity measures. These events, along with a series of governmental financial deficits and a recession, contributed to Puerto Rico's debt crisis.
Causes
Triple tax-exempt bonds
The federal Jones–Shafroth Act of 1917, exempts interest payments from bonds issued by the government of Puerto Rico and its subdivisions from federal, state, and local income taxes (so-called "triple tax exemption") regardless of where the bondholder resided. Triple tax-exempt bonds are considered to be subsidized because bond issuers can offer a lower interest rate to satisfy bondholders.
The triple tax exemption made Puerto Rican bonds highly attractive to U.S. municipal bond investors, and very low cost for Puerto Rican local government to issue. Puerto Rico thus began to issue debt to fund its expenses, a practice repeated for four decades since 1973. The island also began to issue debt to repay older debt, as well as refinancing older debt possessing low-interest rates with debt possessing higher interest rates.
Debt burden
A constitutional amendment in 1952 relaxed balanced budget requirements for Puerto Rico in comparison to the states and another in 1961 loosened the reins on debt capacity, encouraging Puerto Rico to continue to fund fiscal shortfalls through the issuance of triple-exempt municipal bonds. The government was able to issue an unusually large number of bonds in part due to dubious underwriting from financial institutions such as Santander Bank, UBS, Barclays, Morgan Stanley, and Citigroup. Eventually, the debt burden became so great that the island was unable to pay interest on the bonds it had issued.
Cessation of federal subsidies
For much of the 20th century, Puerto Rico was subject to favorable tax laws from the US federal government, which essentially acted to subsidize the island's economy. Section 936 of the Internal Revenue Code established tax exemptions for US corporations that settled in Puerto Rico and allowed its subsidiaries operating in the island to send their earnings to the parent corporation at any time without paying federal tax on corporate income. The economy of the island was significantly reliant on the additional investment and spending generated by companies taking advantage of these provisions.
In 1996, US President Bill Clinton signed legislation phasing out important parts of the favorable federal tax code over ten years ending in 2006. The end of the subsidies led to companies fleeing the island which subsequently led to economic downturn and tax shortfalls.
Economic recession
The repeal of the Section 936 corporate tax exemptions, along with the Great Recession, caused a sharp economic downturn in Puerto Rico. Between 2007 and 2017, Puerto Rico's gross national income declined by 14 percent. In 2015, 46 percent of the population in Puerto Rico lived below the federal poverty line, compared to the U.S. national average of 15 percent.
Government mismanagement
Some newspapers, such as El Vocero, stated that the main problem was local government inefficiency rather than lack of funds. For example, the Department of Treasury of Puerto Rico is incapable of collecting 44% of the Puerto Rico Sales and Use Tax (or about $900 million), did not match what taxpayers reported to the department with the income reported by the taxpayer's employer through Form W-2s, and did not collect payments owed to the department by taxpayers that submitted tax returns without their corresponding payments. The Department of Treasury also tends to publish its comprehensive annual financial reports late, sometimes 15 months after a fiscal year ends, and the government as a whole constantly fails to comply with its continuing disclosure obligations on a timely basis. The government's accounting, payroll, and fiscal oversight information systems and processes also have deficiencies that significantly affect its ability to forecast expenditures. Similarly, salaries for government employees tend to be quite disparate when compared to the private sector and other positions within the government itself. For example, a public teacher's base salary starts at $24,000, but that of a legislative advisor starts at $74,000.
The government has also been unable to set up a system based on meritocracy, with many employees, particularly executives and administrators, simply lacking the competencies required to perform their jobs. There are 78 municipalities of Puerto Rico, which budget $2.2 billion a year, with mayors' salaries alone costing $4.8 million. 36 of these have a budget deficit, putting 46% of the municipalities in financial stress. Each municipality's elected legislature, usually including 1,000 to 1,500 members, receive per diems and expense money. Just like the central government, municipalities would issue debt through the Puerto Rico Municipal Financing Agency to stabilize their finances, rather than make adjustments. In total, the combined debt carried by the municipalities of Puerto Rico accounts for $3.8 billion, or about 5.5% of Puerto Rico's outstanding debt.
During the New Deal, an appointed Governor, Rexford Tugwell, created the Puerto Rico Electric Power Authority (PREPA) by nationalizing the island's private utilities. The state monopoly provides free electricity to local governments, which prompted the mayor of Aguadilla, Puerto Rico, to build an ice-skating rink. PREPA uses oil-fired power plants, has had opaque purchasing practices, has resisted wind and solar power projects, and has a debt of $9 billion. PREPA has had poor bill collection practices, with FTI Consulting estimating that the utility had improperly given away $420 million of electricity and that the island's governments were $300 million delinquent in payments. In 2012, the Puerto Rico Ports Authority was forced to sell the Luis Muñoz Marín International Airport to private buyers after PREPA threatened to cut off power over unpaid bills. In 2014, the Puerto Rico Energy Commission was established. After the neglected power grid was destroyed by Hurricanes Irma and Maria, PREPA was privatized from 2018 to 2021.
More than 60% of Puerto Rico's population receives Medicare or Medicaid services, with about 40% enrolled in the Puerto Rican Medicaid program. There is a significant disparity in federal funding for these programs compared to the 50 states, a situation that Congress started in 1968, when it placed a cap on Medicaid funding for US territories. That has led to a situation in which Puerto Rico might typically receive $373 million in federal funding a year, but Mississippi, a state with a population similar to that of Puerto Rico, receives $3.6 billion. The situation led to an exodus of underpaid health care workers to the mainland, and the disparity has also had a major impact on Puerto Rico's finances.
2014 downgrade
Multiple bond-rating agencies downgraded Puerto Rico's debt to non-investment grade in early 2014. On February 4, Standard & Poor's downgraded Puerto Rico's general obligation debt (GO) from BBB− status to BB+, one level below investment grade. The agency cited liquidity concerns for its downgrade and maintained a negative outlook on its watch. Three days later, Moody's downgraded Puerto Rico's GO debt from Baa3 to Ba2, two levels below investment grade. Moody's, however, cited lack of economic growth for its downgrade while assigning a negative outlook to the government's ratings. Fitch Ratings would be the last to downgrade on February 11, 2014, by downgrading Puerto Rico's GO debt from BBB− to BB, two levels below investment grade. Fitch cited both liquidity concerns and lack of economic growth for its downgrade while assigning a negative outlook to the government's ratings. These downgrades triggered several acceleration clauses, forcing Puerto Rico to repay certain debt instruments within months rather than years.
2015 forbearance
On June 28, 2015, Governor García Padilla admitted publicly that "the debt is not payable" and that if the government was unable to grow the economy, "we will be in a death spiral. Before Padilla's admission, various government instruments had already entered into forbearance agreements with their lenders, but the warning still provoked a drop in Puerto Rican bonds and stocks.