How serious was the default by Puerto Rico on its bond obligation? As a member of parliament and associate minister of finance during the recovery in New Zealand during the mid-1980s when the commonwealth almost went bankrupt, I have firsthand knowledge of how difficult recovery is — but I also know that it is possible.
I can tell the people of Puerto Rico that the recovery will be painful. Individuals may find that borrowing is more difficult and expensive. The government may want to tax its citizens more heavily. And the commonwealth’s creditors may be compelled to renegotiate their debt holdings. This is very serious, indeed.
Puerto Ricans may find that many of the government-paid benefits will need to be reduced significantly. In the case of New Zealand, this reduction in benefits was as much as 30 percent. The civil service was reduced by 66 percent. The Puerto Rican government will need to be reduced in size by as much as 40 percent. But the quicker the adjustments are made, the quicker people and the economy can get back on a path to growth. Even then, vigilance will be required to keep fiscal distress from creeping back again — and keep the political class from revisiting its big spending tendencies.
So, is this all just a financial hiccup that will quickly go away or could it cripple the island for a generation? To answer that question, one would benefit from a frame of reference that compares factual financial information about Puerto Rico with other commonwealths within the United States — some of which are quite troubled, and many of which could learn from Puerto Rico’s mistakes.
Fortunately my colleagues at the Mercatus Center at George Mason University recently released a study on the solvency of all 50 states that provides the most comprehensive ranking of state fiscal health to date, using states’ own audited annual financial reports. This study ranks the states from the most fiscally solvent to those at the highest risk. Given Puerto Rico’s financial straits, the same scholars have now applied these standards to the island — and in all but one category Puerto Rico is worse than all 50 states. This information shows that Puerto Rico’s financial problems are not easily solved nor can they be quickly repaired.
A closer look at its financial statements accounts for Puerto Rico’s dire situation: Both Puerto Rico’s budget solvency and long-run solvency are roughly twice as poor as that of New Jersey, which finishes 49th on each, according to the study’s metrics. The commonwealth has only 50 percent of the cash needed to cover short-term bills, its long-term liabilities are about five times larger than the average state’s and its obligations to public employees are large and almost entirely unfunded. Overall, Puerto Rico’s fiscal performance is far worse than that of the most fiscally distressed states of Illinois and New Jersey.
How did Puerto Rico get into so much trouble without anyone noticing? This evolving financial position has been apparent in the island’s financial accounts for at least the last 20 years, but one after another, politicians refused to acknowledge that the island was heading for bankruptcy unless they made some tough decisions immediately. For the politicians, the next election was more important than financial solvency.
To be fair, we should not heap all the blame on the politicians. The bond-issuing agencies also deserve a share of blame — after all, they let tax-free earnings on the island’s bonds seduce them into lending when the financial fundamentals said the risk was too high. Irresponsible lenders made money available to irresponsible politicians who spent the island into bankruptcy — so we shouldn’t be unduly sympathetic to the bond holders who were the architects of their own misery.
What of the consequences? The saddest immediate consequence is that some talented people with readily marketable skills will leave the island and leave an economy bordering on — if not fully collapsing into — recession for a considerable time. Companies will also join the exodus in search of more attractive environments.
What’s the solution? A bailout is unlikely — and as Greece found out, to qualify for a bailout you have to surrender a lot of sovereignty. The best solutions will be home-grown and leave the decision-making authority in Puerto Rico.
Some have called for the creation of a financial control board like that used by the District of Columbia when it almost went bankrupt in the late 1990s. Using this model, the island’s governor and legislature would have to vest authority in a board of qualified citizens to do what’s necessary to reestablish the commonwealth’s creditworthiness. The role of the governor and legislature would become more ceremonial in nature until the emergency subsides.
What could the board do? First, it should seek some accommodation from the island’s creditors. Next, immediately liquidate as much cash as possible for the repayment of debt. This might entail privatizing a large portion of the island’s assets like government-owned utilities, ports, airports, enterprises, land, etc. The commonwealth desperately needs capital to pay down debt, not be held captive by enterprises that are frequently more of a liability to the government than a revenue producer.
Having stabilized the island’s finances, the board should then turn its attention to dramatically improving the island’s competitiveness to attract investment capital and move the economy back into a growth phase. In the end, emerging from this crisis will depend on creating a vibrant, growing economy.
For any naysayers, recall the experiences of island nations that have done this: Singapore, which turns 50 years old this month, was once one of the poorest places on earth. Today, it’s one of the few places where there is virtually no poverty. Up until the late 1980s, Ireland was one of the poorest countries in Europe, and by the time of the Great Recession it came roaring back with the second highest per capita income. And through dramatic reform and market-driven policies, my native New Zealand paid down most of its debt and is currently running fiscal surpluses.
Recovery is possible, but if the leaders of Puerto Rico think it can be achieved without hardship and tough decisions, they should recuse themselves immediately because they will not be part of the solution.