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Blue Model Blues
Puerto Rico Crisis: Coming Soon to the Mainland

The problems that forced Puerto Rico belly-up—first and foremost, a bloated public sector and untenable pension obligations—are not confined to Puerto Rico, the island’s governor reminded U.S. policy wonks in a speech last week. Alejandro Padilla’s government may be the largest to go bankrupt so far, but that dubious distinction may be tested in the near future. Governing magazine:

Puerto Rico, like states and many cities, can’t legally declare bankruptcy. Saddled with $70 billion in debt, Gov. Alejandro Garcia Padilla’s administration has spent the last few years unsuccessfully trying to reach an agreement with creditors. During that time, the commonwealth watched its tax base decline as residents fled stateside and Puerto Rican government entities defaulted on debt.

That’s what life without bankruptcy protection is like for governments, Padilla said this week in a speech at the Brookings Institution in Washington, D.C. He went on to suggest that Puerto Rico, with its smaller economy and population size, might simply be farther along on a path other U.S. governments are also traveling. “We are only ahead of the curve — the curve that looms for many states and municipalities,” he said.

Padilla is entirely right. At over three trillion dollars, according to some estimates, America’s state and local pension crisis is much worse than most policymakers understand. Cities like Stockton and Detroit have already filed for Chapter Nine, and there are murmurs that Chicago might do the same if it experiences another blow to its fiscal health. In fact, it seems downright likely that the next recession will bring a wave of Puerto Rico-style municipal bankruptcies.

The collapse of recklessly-managed state and local finances on the mainland will create a political crisis of far greater proportions than Puerto Rico’s struggles. Congress should heed Padilla’s advice and start pressuring states and localities to get back on track. It should also develop a framework for managing these meltdowns if and when they do occur (Will assistance be available? On what terms?) as they do occur, so as to avoid extended squabbling and gridlock when the rubber meets the road.

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  • Andrew Allison

    Interesting that a publication with the name “Governing” is unaware that cities and counties can declare bankruptcy. And as for Congress developing a framework for managing these meltdowns when they inevitably occur, surely you jest. The writing has been on the wall for quite some time now, and Congress has done nothing.

    • Greg Olsen

      Chapter 9 bankruptcy does not trump state sovereignty. Not all municipalities are permitted to file under Chapter 9, because the sovereign state much authorize the action by statute. For example, California does, but Nevada does not. Governing is correct when it states: “Puerto Rico, like states and many cities, can’t legally declare bankruptcy.”

      • Andrew Allison

        I stand corrected but, given that the alternative is for the State to be sued, it seems unlikely that a State would not authorize a bankruptcy when all else fails. Nevada, incidentally, has adopted a process whereby a distressed
        local government that meets certain criteria can ultimately be placed in “Severe Financial Emergency” status, bankruptcy in all but name.

      • klgmac

        My understanding is the Territories can’t, states can’t, but municipalities can if permitted by it’s home state. Don’t worry though, they’ll find a legal workaround to recognize reality.

  • Josephbleau

    Was not Detroit the largest government to go bankrupt?

  • klgmac

    The Fed’s ZIRP is punishing savers and crushing, banks, insurance companies and pension funds. If they were trying to crash the financial system on purpose, what would they be doing differently?

  • http://whenfallsthecoliseum.com/author/kwatson/ megapotamus

    There is another way the Puerto Rico crisis is coming ashore. Anyone with any muni fund or holdings of any diversified size has Puerto Rican bonds. They might not hold bonds but still have exposure through derivatives. You may well say, default/bankruptcy is the way to go, and it is. Default of some sort is inevitable. The more baroque the form comes the more expensive it will be to the entire investing public. Is that you? You might think not but don’t be too sure. If you have a bank account, baby, you are an investor.

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