Puerto Rico bondholders are in for an unpleasant start to 2016 as the island announces that it will default on some of its debt payments on New Year’s Day. The NYT:
In a briefing for journalists, Gov. Alejandro García Padilla said only some of the payments would be halted immediately. They include $35.9 million due to holders of bonds issued by its Infrastructure Financing Authority, and $1.4 million due to holders of its Public Finance Corporation’s bonds.
In a stark example of the financial version of musical chairs that has been playing out on the island in recent months, the government will divert a total of $174 million from lower-grade bonds to pay holders of the legally protected general obligation bonds. That diversion, known as a “clawback,” technically amounts to a default even though some of those creditors will not see a difference in their payments on Jan. 1.
Puerto Rico was already in default, and no one seems to have expected that it would make this payment in its entirety. But the official announcement underscores the fact that there is no end in sight for the island’s crisis. The appetite in Congress for a bailout or bankruptcy protection appears to be minimal, and it seems likely to stay that way for the near future unless and until Puerto Rico’s woes start to hit the mainland in a major way—a prospect that is not inconceivable, but which advocates of a no-strings-attached bailout have every incentive to exaggerate. So in the short term, the island will probably be forced to continue grinding it out on the backs of its own taxpayers.
In the medium term, as we have said before, there is a role for Washington in bringing Puerto Rico’s crisis under control. The guiding principle of U.S. government involvement should be “relief for reform“—that is, Puerto Rico should be eligible for meaningful assistance in servicing its debts if and only if it can make profound structural changes to the decrepit blue model governance system that landed it in this mess. Finally, in the long term, the island may face an even more radical choice: either remain a colony or pursue either outright independence (where it could rise or fall on its own in the debt markets), or, after top-to-bottom reforms, statehood (which would relieve it of various hurdles to solvency, and allow for state and local bankruptcies). Neither of those second two options would be easy, but the depth of the current crisis shows that the status quo has fundamentally failed.