It may not be front page news in Arkansas, but Congress is currently grappling with a very important issue – how to respond to Puerto Rico’s staggering debt. How members of Congress deal with Puerto Rico will give us a glimpse of how the federal government will deal with future supplicants coming to Washington to beg for a bailout. And given the huge load of debt carried by local governments, these supplicants will be certainly be coming.
In an op-ed for the Washington Post, Rep. Bruce Westerman sums up Puerto Rico’s problems nicely:
The island territory has a shrinking population of 3.6 million with a gross domestic product slightly over $100 billion, but is carrying $71 billion in debt with another $44 billion in unfunded pensions – equaling a debt of roughly $32,000 per person. Additionally, Puerto Rico’s labor participation rate is less than 40 percent. This means fewer taxpayers and a substantially higher debt load for wage earners.
Why is Rep. Westerman so interested in this issue? It’s because he is a member of the House Natural Resources Committee. That is the congressional committee with jurisdiction over U.S. territories like Puerto Rico. As a U.S. territory, Puerto Rico’s fiscal problems are, to a certain extent, a problem for Congress to grapple with. The fiscal mismanagement on this small island has reached such gigantic proportions that it creates a big headache for Rep. Westerman and his colleagues.
Some members of Congress have proposed restructuring Puerto Rico’s debts. This would involve bondholders taking a loss for extending credit to the island. J.W. Verret, a senior scholar at the Mercatus Center at George Mason University, explains why this is a dubious course of action:
These bonds were sold with the expectation that any creditor would have a chance to be the “holdout” creditor, and the holdout option was priced into the initial purchase. It is a clear violation of the creditors’ contractual rights to now take away that contract right. If Puerto Rico wanted to deny creditors a holdout right, it should have specified that in its debt contracts.
Economist Stephen Moore puts it this way:
Bondholders would suffer a government ‘taking’ of their property for political expediency — what Third World countries do when they get into trouble. And make no mistake: Pension and retirement funds, not just fat cats, would take the hit and lose billions of dollars owed to them.
Rep. Westerman points out that, back in 1933, Arkansas went through a similar situation. It defaulted on paying its bonds in that year, but it did not receive any federal help. Instead, it rebuilt its fiscal house on its own — and did not issue bonds for another 16 years. This was a necessary, if painful, process that resulted in a stronger Arkansas.
If Congress allows Puerto Rico to set up a system to evade its financial responsibilities, it will remove the incentives for Puerto Rico to do something similar. There are a variety of structural issues with the territory that have led it to today’s situation. The federal government mandates that island employers pay the same minimum wage as on the mainland, even though, as columnist Charles Lane points out, “a full-time job at the minimum wage of $7.25 pays 77 percent of Puerto Rico’s per capita income, compared with 28 percent in the United States.” In addition, Puerto Rico has strict labor laws governing overtime and job security. Coupled with generous welfare benefits, these policies have led to a workforce participation rate under 40%. As Rep. Westerman says, “Puerto Rico is a case study in spurning the tenets of free enterprise for big government.” If the commonwealth’s leaders reversed these policies, it would go a long way towards helping end the fiscal crisis.
Congress has a choice to make: either let Puerto Rico off the hook for its bad policy decisions, or help the territory enact new policies that will lead it to a brighter future. The decisions of federal legislators will have wider ramifications than what happens in Puerto Rico. The path taken today will help inform what happens in years to come. That’s because Puerto Rico is not alone in pursuing anti-growth policies coupled with high government spending. State and municipal governments have incurred long-term debt obligations that will pose huge fiscal problems in the years to come. If Puerto Rico gets to avoid its debt through Congressional action, why can’t these governments do the same?
Some point to a legal obstacle to Congress bailing out state and local governments the same way as it does Puerto Rico. Marc Joffe, the Principal Consultant at Public Sector Credit Solutions, points out that “The Territorial Clause of the Constitution gives Congress the power to create a regime under which Puerto Rico’s bonded debts can be restructured. By limiting this mechanism to territories, Congress can avoid any possibility that it will be later applied to US states.”
This may be technically true, but it misses the larger political picture. If the federal government bails out Puerto Rico, it will only invite other fiscally irresponsible governments to come begging to Washington, D.C. There are many other cities or counties that could easily end up in the situation of Puerto Rico. If Congress allows Puerto Rico to escape its responsibility to bondholders, then there will be a growing chorus of politicians calling for a similar policy option for other local governments that have run up too much debt. This has happened in the past, and it could easily happen again.
As Heritage Action points out:
States may reasonably conclude that Congress will be willing, when the time comes, to change bankruptcy law in their favor, offer a stay of litigation, and/or offer them novel mechanisms for restructuring their debt. If this narrative takes hold, it will increase moral hazard and encourage more fiscal irresponsibility among states.
The debate in Congress over Puerto Rico’s debt is important for two reasons. The first is that those who lent money to Puerto Rico deserve to have it repaid under the terms of their contract with the territory. The second reason is because Puerto Rico is not alone – its problems could easily be the problems of many cities and counties over the next few decades. How Congress handles Puerto Rico will set a standard for future action on municipal bailouts. Rep. Westerman is wise to sound a note of caution on this issue: he deserves plaudits for warning the nation, among other things, that this is a much more significant question than it might at first appear.