Puerto Rico appears to have avoided defaulting on the bond payments due Tuesday. The Economist argued this week that, “one way or another,” the U.S. government “will end up bailing out Puerto Rico.” But the editorial supports that conclusion with two factual errors.
First, the editorial says that Puerto Rico’s “government owes $72 billion in debt.” The majority of that debt is owed not by the Commonwealth of Puerto Rico but by public corporations and specific government authorities (See Tables 1 and 2 in this primer). Contrary to the Economist’s assertions, if those debts go unpaid, the result will be that bondholders lose money and public utilities go into receivership, which may finally result in much-needed reforms and reinvestment. The bondholders cannot force tax increases.
Second, the editorial seems to suggest that because the U.S. Bankruptcy Code does not apply to states and territories, there is no way for them to default on their loans. But several U.S. states and the Territory of Florida have defaulted before, in 1841. Defaults, not bailouts, are the proper fail-safe for irresponsible lending. If Congress follows the Economist’s fatalist logic, lenders will come to expect bailouts and will happily enable state and local governments to write checks they might have no plans to honor.
Puerto Rico’s public bonds were issued within specified legal frameworks. Those who bought and sold the bonds can work out the insolvencies under the rules they agreed to when they entered the contract. Changing the bankruptcy rules at this juncture would set a precedent for tilting the law in favor of political entities.
In the absence of a bailout, Puerto Rico’s utilities would be forced to deal directly with their creditors, as the electric company PREPA has done for the past few years. Those internal reforms are often painful for insiders, but they are good for customers and they would improve the utilities’ long-term viability. The commonwealth may be forced to default on some debts, possibly through an agreement with creditors. The creditors would be wise to demand structural reforms to Puerto Rico’s economic regulation and fiscal process, without which the prospects for future repayment are dim. A bailout would short-circuit this process, leaving in place the corruption, patronage, and unresponsive government that has prevented Puerto Rican incomes from catching up with those on the mainland.
This piece originally appeared in the Wall Street Journal