The Plot Against Puerto Rico

In 1809, one year after Napoleon sacked Madrid, deposed the autocratic King Ferdinand VII, and made his brother Joseph the king of Spain, the country’s parliament was summoned for the first time in decades. Among its legislators was Ramón Power y Giralt, a Puerto Rican elected by the island to represent the then-colony. He was the first Puerto Rican ever to cast a vote in a national parliament, and likely the last.

Power’s life was nasty, brutish, and short. He died in 1813 at the age of 37, victim of a yellow fever epidemic, but not before serving as the vice president of parliament and helping to write the Constitution of 1812 — a revolutioary document that provided for universal male sufferage, freedom of the press, constitutional restraints on the monarch, and new economic incentives for Spain’s colonies. Waterloo, of course, ended the liberal 1812 Constitution and put Puerto Rico back under the thumb of imperial Spain, at least until the island was ceded to the United States after the Spanish-American War in 1898. Yet Power wielded more authority under Napoleon’s conquered Spain than Pedro Pierluisi, the island’s current nonvoting member in the U.S. Congress.

For the past 118 years, Puerto Rico has existed as an anamoly, geographically closer than Hawaii or Alaska to mainland United States, yet ruled like distant Guam or American Samoa. In keeping with America’s somewhat self-deceiving anticolonialist ethos, the island was deemed a “possession” during World War I. For most Americans, the island is known best for the 20th-century migration of Puerto Rican families to the mainland, mostly to New York City, a byproduct of the deal that extended the draft to the island’s young men. Now, the migration has begun anew, again to New York but also to Florida, Chicago, and the American southeast. Driven by an economy in free fall, more than 50,000 people have been leaving for the mainland each year, and disproportionately represented in those numbers are the most ambitious, educated, and employable Puerto Ricans.

This is the context of Puerto Rico’s current fiscal crisis. Its $73 billion government debt is many times worse than any U.S. state’s burden in per capita terms, including the reigning champion of U.S. state-level fiscal dysfunction, Illinois. San Juan cannot raise enough tax money locally to pay — or even service — that debt and wields only partial control over the economy: While it can cut government spending, trim the public sector, and pass laws to make the island more attractive to establish businesses locally, the big decisions lie in Washington. Because Puerto Rico does not have its own currency, it cannot devalue its way out of debt. It is tethered to a much larger entity that, even in the worst of times, wonders whether the failure of a small Caribbean possession is really worth its time.

Many in Congress treat the island’s plight like a mere annoyance — or, at best, yet another way to highlight all that is wrong with the other party’s approach to government. Yet Congress has jealously, even imperiously, guarded its control of some of the basic realities of the island’s economic and political life, insisting that the United States can tap it for soldiers when needed, for instance, and refuse to extend the right to vote in U.S. elections or even congressional matters. Even the island’s notoriously high prices for basic goods should be laid at the steps of the Capitol building: In 1920, as a sop to the U.S. maritime industry, Congress passed the Jones Act, which required shipping between U.S. states or possessions to be carried by U.S.-flagged ships manned by American crews. To say this is uncompetitive in the modern world is a vast understatement. A University of Puerto Rico study from 2012 found the practice costs the island’s economy about half a billion dollars annually. That windfall also adds U.S. shipping companies to those fighting debt relief for the beleaguered island.

Over the past 20 years, investment incentives approved by Congress, most notably a provision making investments in the island’s pension fund tax-exempt, have made its government debt as attractive as any bonds in the world. Large banks and investment fund managers plowed their clients into these bonds assuming, not unreasonably, that the United States would never allow the island to default. Yet these new incentives were enacted just as Congress decided to rescind an even more important spur to the island’s economy: Section 936 of the tax code, which allowed multinationals to avoid all tax on operations based on the island. Following its repeal in 1996, the island’s apparel, plastics, and rubber manufacturing sectors lost thousands of jobs; the same happened to computer and electronics, following a brief spike in employment. Companies chose to relocate to Mexico, Asia, and elsewhere. An economy that had grown steadily during the 1970s and 1980s suddenly seized up. It’s current recession has lasted since 2006, undermining the “invest in paradise” pitch many fund managers proffered.

For several years, the island has warned that its ability to survive scheduled interest payments was in doubt. Then, last December, facing a tsunami of dollar-denominated debt, the island’s governor, Alejandro García Padilla, announced that Puerto Rico would default on a $422 million interest payment on May 1 unless the U.S. government intervened to allow restructuring.

That threat has had several results. The first, perhaps unintended result was that alarm in global financial markets effectively ended the island’s access to borrowing of any kind. Since San Juan was using borrowed money to pay for routine government operations — a sure-fire prescription for insolvency — the “default unless the United States intervenes” threat is now fait accompli.

García Padilla’s announcement also set off the usual round of hard-nosed negotiations — though, to use that term is to suspend disbelief — between creditors and the sovereign. Bondholders, pensioners, and others have been in talks with the government, and the New York-based OppenheimerFunds and Franklin Templeton — funds whose clients together hold about 10 percent of the $73 billion total — are particularly averse to accepting less than the full value of their bonds. The Argentine government’s decision last month to repay $12 billion in bonds to hedge funds stemming from its own default 15 years ago is likely to harden the resolve of Puerto Rico’s creditors. A precedent has been set: Why settle for pennies on the dollar when U.S. courts will back your claims for full restitution?

And what of Washington? From Republicans and Democrats in Congress, the White House, and those trying to get there, the Puerto Rican question has become a political football. Almost universally, all sides condemn Puerto Rico’s poor record of financial governance. Yet all seem to be falling short of politically workable solutions.

Congressional Democrats, including many from states with large Puerto Rican constituencies, talk more generously of changing the law — which, of course, requires the assent of Republicans — to allow the island to declare bankruptcy under Chapter 9 of the U.S. bankruptcy code, the provision used by Detroit and other insolvent municipalities. Critics such as Rep. Tom McClintock, a California Republican who has publicly challenged this approach and expressed fears that such a move would encourage states to follow suit, presaged a stampede of fiscal invalids that would threaten to undermine the U.S. municipal bond market. The idea, in short, is going nowhere.

U.S. President Barack Obama and Treasury Secretary Jacob Lew favor something slightly less radical, though no more likely to see the light of day: a specially tailored form of bankruptcy power for Puerto Rico that avoids reference to Chapter 9 and an expansion of the earned-income tax credit, a kind of reverse income tax that provides a subsidy to the lowest earners, plus an increase in federal Medicaid directed to the island. Republicans aren’t exactly enthusiastic about this idea. Particularly in an election year, anything smacking of a “bailout” — particularly of a loyal Democratic constituency — is political poison.

Yet the lack of alternatives means the GOP’s preferred response to the crisis may have a chance. Aired in late March, the idea is contained in a draft bill co-sponsored by House Speaker Paul Ryan and Rob Bishop, chair of the House Natural Resources Committee, which (confoundingly) has jurisdiction over Puerto Rico. It would create a five-person oversight board to effectively run fiscal policy in Puerto Rico and impose an austerity budget, as well as a stay on litigation that bondholders oppose. Given the gridlock prevailing in Washington, even with Ryan backing the bill, this is a long shot at best. Democrats have already rejected it, due to their preference for seeing investors take a haircut as Puerto Rico restructures.

But Ryan and Bishop have taken a beating for their efforts, too. Since mid-March, a group calling itself the “Center for Individual Freedom” has spent $2 million filling the airwaves of Bishop’s home district with attack ads accusing him of “standing with the Obama administration to support a bailout of Puerto Rico,” a charge in Utah akin to drowning puppies. The group also bought national airtime on MSNBC, CNN, and Fox News — a not-so-subtle message to Ryan himself. And while its benefactors are frustratingly opaque, its message tracks exactly with that of the investment banking industry: that a “bailout” would wrongheadedly reward Puerto Rican profligacy and, instead, that investors should be able to wrangle with the island’s government directly through the courts.

Whether Ryan’s efforts in the House, as thankless as any in recent memory, can stave off this dark scenario remains uncertain. His approach will require an unusual degree of political courage in an unusually fractious election year. It also asks Republicans, both in the House and eventually the Senate, to put aside their fiscal dogma in the face of an emergency that, at least viewed superficially, none of them have much of a stake in.

So, now what? Should debt talks fail, Ryan’s bill die in committee, and Obama refuse to use executive power to bail out the island, things will get ugly. Criminal syndicates, drug gangs, and street crime — already present on the island — will grow. Following a likely default in May, branch offices of banks will likely stop processing financial transactions, with a full shutdown of government and commercial activities to follow. This will almost certainly lead to significant unrest, as government salaries and pensions go unpaid, and angry retirees and public sector workers, who make up by far the largest chunk of the island’s economy, take to the street in protest.

A declaration of emergency will follow. Puerto Rico’s Army National Guard, whose 7,200 troops already patrol the crime-ridden island’s streets, will need to backfill for police who can no longer be paid. Government currency controls to prevent dollars from leaving the island may be imposed. Within a few weeks, the results of a collapse of vital government health and welfare services to a population that is older and less healthy than that of any U.S. state will be a scandal — and this, just as the Zika virus makes its stealthy way northward.

The Constitution of 1812 is looking better all the time.

Photo Credit: Joe Raedle / Staff