Puerto Rico Default and What It Means

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Puerto Rico
Puerto Rico has made headlines by defaulting on its debt payments and what it means for the future of the country. Puerto Rico is a commonwealth territory of the United States. The Caribbean island has essentially been a colony, with no voting rights in the United States legislative branch, for more than a century. The payment missed was a $58 million bond, save for $628,000 they were able to pay.

Governor Alejandro Garcia Padilla has expressed concern over the country’s ability to pay its debt during the current recession. The $58 million payment was the only missed payment out of a total monthly amount of $483 million. This single payment is only a fraction of the total outstanding debt Puerto Rico holds of approximately $70 billion. The missed payment was to the creditors of the island’s Public Finance Corporation (PFC). Strategically speaking, the government chose that debt to default on as the holders of the debt are credit unions and Puerto Rican citizens with very little legal recourse in collecting on the debt. The rest of the debt that was paid is held mostly by large hedge funds with the power to collect.

It is widely believed that this is the first of many strategic defaults on the debt the country owes to the commonwealth citizens. As long as Puerto Rico continues to default, it would mean the country’s credit would continue to rate as junk. When that is the case, bond prices plummet. When bond prices are low, trading occurs less and investors lose money. All of these things were seen in Greece over the last few years and in the United States when the Great Recession began in 2008.

There is an interesting issue at hand, though. Puerto Rico guarantees that these commonwealth bonds will be paid back in its constitution. That guarantee is what drove investors to purchase the bonds in the first place. These bond sales are how the country was able to fund many government projects including infrastructure improvements and social programs. It has yet to be determined how defaulting on this constitutionally guaranteed debt will affect the government and the citizens of Puerto Rico.

Again, it is important to note that this default, as well as the expected future defaults, is a strategic move by the government. Government officials have been urging creditors to work with the country and restructure debt for months leading up to this default; however, very little restructuring of any debt has occurred. Now the country is caught between a rock and a hard place. What Puerto Rico does not have, is the money to pay back debt or the revenue necessary to do so in the future. This is a direct result of the current economic recession. This also means Puerto Rico does not have the money necessary to invest in its own economy to help recover from the recession and it has almost no ability to borrow the funds.

One potential option is bankruptcy; however, there are no current laws on the United States books that allow for a colony (or commonwealth territory) to file. It has been thrown out that the United States should allow Puerto Rico to have statehood, but that would be no help as bankruptcy is not legal for states, only cities. If action is not taken soon, Puerto Rico’s default could mean facing a Greece level financial crisis; which means directly and negatively affect the United States.

Although many would argue the benefits of government spending through a recession, one thing has been painfully obvious during the Greek financial crisis: Austerity measures in the face of economic recession exacerbates the situation. This is why early action is necessary.

By Charles Jackson
Edited By Leigh Haugh

CNN: Puerto Rico Just Defaulted for the First Time
New York Times: Puerto Rico Has Another Debt Worry on Horizon
Wall Street Journal: Puerto Rico Defaults on Most of $58 Million Debt Payment
Featured Image Courtesy of Kevin Baird’s Flickr Page – Creative Commons License