Puerto Rico Blues
Time to Choose: Statehood or Independence

Puerto Rico, which already defaulted on its obligations to creditors in August, has announced that it will likely run out of cash again next month, ahead of a $354 million debt payment due on December 1. The island has not been able to borrow more money (efforts to issue new bonds fell apart this summer), and even the extraordinary measure of liquidating the territory’s securities holdings will apparently not enable Governor Alexandro Padilla to make ends meet in November. Various ideas are being floated in the U.S. Congress to address the looming crisis—fiscal oversight boards, loan guarantees, and even extending Chapter 9 bankruptcy protection to the territory. Most of these plans appear to be dead-on-arrival. While Democrats are urging debt relief, Republican lawmakers are insistent that Puerto Rico should not get bailed out by the U.S. government.

One plan, however, appears to be getting traction: The U.S. Treasury and the government of Puerto Rico are in discussions about the possibility of the U.S. issuing a “superbond” for the territory, backed by a U.S.-administered fund that would hold at least some of the island’s tax revenue. The superbond would be issued to current bondholders at some yet-to-be-determined ratio, in effect giving bondholders a haircut in exchange for more assurance that they would get paid—all without the U.S. government explicitly underwriting anything. The Wall Street Journal has an overview of how this might work:

Under the plan, the Treasury or a designated third party would administer an account holding at least some of the island’s tax collections. Funds in the account would be used to pay holders of the superbond, which would be issued to existing Puerto Rico bondholders in exchange for outstanding debt at a negotiated ratio.

Investors would receive less debt, likely taking an effective “haircut” on the value of their holdings, but would have higher expectations for getting repaid.

The proposal would mark an important change in Puerto Rico’s relationship with the U.S. government, which has resisted wading into the island’s debt morass. A superbond would need to clear high political hurdles in Washington and Puerto Rico to become a reality. Discussions with bondholders over the size of any haircut could present further challenges to reaching a deal.

As the Journal says, even this plan, which effectively asks bondholders to trade writedowns for somewhat more security, faces several stumbling blocks. For one, the arrangement could face legal challenges. For another, bondholders, who are currently first in line to get repaid in case of liquidation, are concerned about the likelihood of success. The plan could include IRS personnel helping Puerto Rico with actually collecting taxes, which currently is not done very efficiently. But it’s far from certain that the IRS would be all that much more successful.

In the end, however, the prospect of the U.S. Treasury administering Puerto Rico’s tax collections points to the fact that the status quo has failed. It increasingly looks like the island should be moving toward either statehood or independence over the long run. If Puerto Rico were independent, it could stand or fall on its own in sovereign debt markets. If it were a state, its government wouldn’t need to deal with hurdles to solvency like the Jones Act and different Medicare and Medicaid reimbursement rules, and it could provide for state and local bankruptcies. Neither of these options would be easy, and the statehood option in particular shouldn’t be sugarcoated; to be viable, the island would need to undergo major reforms and become fiscally responsible, a painful and tumultuous process.

The superbond idea currently gaining traction may or may not be a part of the solution to the current crisis. But superbond or no, the island’s leadership should be thinking about how things would work out if it moved toward either statehood or independence. After nearly 120 years under the U.S. flag, Puerto Ricans need to choose: state, nation, or permanent colony.

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