Blue Meltdown
Puerto Rico Girds for Default

Puerto Rico is set to default on the first of several payments on December 1, which will end up totaling $1.5 billion through the end of January. Puerto Rico’s finances have been deteriorating since as early as 2006, with the bulk of the debt burden currently facing the territory stemming from liabilities in pensions programs. As the Economist notes, the largest government pension program is only 0.7% funded at this point. More:

State pension pots are not in quite such bad shape, but massive liabilities still loom. In Illinois, where the labour force has shrunk by about 3% since 2007, pensions are just 39% funded. Puerto Rico will not be the last local government to run out of money.

Perhaps for that reason, many politicians are adamant that the federal government should never rescue insolvent localities. Detroit, for one, was left to write down its debts in bankruptcy court. Puerto Rico cannot do that. The law bars states and territories from declaring bankruptcy, in order to deter profligate behaviour.

President Obama released a plan earlier this year that tries to address some of these problems (here‘s Peter Orszag’s eloquent defense of it as the best way forward). It calls for increasing the cap on federal Medicaid payments to the territory, on largely humanitarian grounds, to match what the Washington already pays out to the 50 states. It calls for bringing the Earned Income Tax Credit in Puerto Rico to encourage labor force participation. But more controversially, it seeks to extend Chapter 9 bankruptcy protection to the territory as a whole—something that the states themselves don’t have (although individual municipalities within them do). In exchange, the plan proposes to impose a fiscal oversight board on the territory’s government, not unlike the one imposed on the District of Columbia in 1995.

The devil is in the details, of course, and the Obama plan recognizes that the implementation of both the bankruptcy protection and an oversight board would have to be left to Congress. With the first default days away, little progress has been made.

We ourselves would favor holding as tough a line as possible on the eventual deal, strictly conditioning relief for reform. We need a policy mix that offers a real chance for recovery, both by forcing the necessary changes on what is clearly a failing approach to government, and in terms of creating conditions under which a refinanced and reformed jurisdiction can actually succeed. And we definitely need to be mindful of the precedents Puerto Rico ends up setting.

It’s patently obvious that there is no way out of this mess without paying some money. But the need is to make sure that the money ends up being well spent.

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