Puerto Rico Doesn’t Need Bankruptcy

Washington’s rush to allow PR to default is about votes not economics.

Puerto Rican Gov. Alejandro García Padilla delivers a budget address in San Juan, April 30. PHOTO: ASSOCIATED PRESS

Puerto Rican Gov. Alejandro García Padilla delivers a budget address in San Juan, April 30. PHOTO: ASSOCIATED PRESS

Nov. 1, 2015

Debt service will consume less than 17% of Puerto Rico’s consolidated budget this fiscal year. In the general-fund budget, which does not include government-owned corporations and agencies, debt service is below 16%. Neither number sounds like grounds for declaring bankruptcy. Factor in all the fat in government spending that could be cut, and the case for walking away from obligations to creditors is even weaker.

But the U.S. is entering a presidential-election year and pollsters say voters tend to choose the candidate who “cares about people like me.” Puerto Ricans living on the island don’t vote, but those on the mainland do. What could say “caring” to these Hispanic voters in places like Florida, Ohio and Pennsylvania more than federal permission to write-down Puerto Rico’s $73 billion in debt?

Right on cue, Treasury wants Congress to approve legislation that would allow Puerto Rico to declare bankruptcy. In an analysis posted on its website, Treasury finds debt service as a percentage of the general-fund budget is actually 38%, which is to say that it believes the way Puerto Rico has been calculating its debt-service burden for the last 40 years is wrong. It would be interesting to know how that got by all the credit-rating firms, lawyers and bond underwriters.

It is also worth noting that Puerto Rico’s debt burden includes $18.5 billion in debt that under the island’s constitution must be serviced before any other payments come out of the general fund.

In a July 28 letter to Senate Finance Committee Chairman Orrin Hatch, Treasury Secretary Jacob Lew wrote, “I am deeply concerned that a protracted and disorderly restructuring process will cause long-term damage to the health, safety, and financial well-being of the families living and working in Puerto Rico.”

Treasury counselor Antonio Weiss ratcheted up the alarm in Oct. 22 Senate testimony. “Puerto Rico’s fiscal crisis is escalating,“ he said, adding “that without federal action it could easily become a humanitarian crisis as well.”

Such hyperbole is designed to rush Congress into approving the bankruptcy law. Yet there is little evidence that Puerto Rico faces a humanitarian crisis any more than the heavily indebted states of California or Illinois. And as to the deteriorating fiscal environment, it seems to be largely the work of Gov. Alejandro García Padilla, who has been signaling markets that default is a policy goal.

As Carlos Colón de Armas, a professor of finance at the Graduate School of Business at the University of Puerto Rico, told me last week, “If, instead of doing everything it can do in order not to pay, the government of Puerto Rico were doing everything it could do in order to pay, things would be very different.”

Mr. Cólon de Armas argues that Puerto Rico will lose its ability to borrow in the capital markets if it defaults and that won’t be good for island development. Nor will it address the fundamental problem of government spending beyond its means, financed by borrowing, a practice that dates back to fiscal year 2000-01.

As I noted in a July 6 Americas column, Gov. García Padilla increased expenses by almost $600 million in his first budget after taking office in 2013. While he has cut from that increase since then, Mr. Colón de Armas told me in July that at least some $500 million-$800 million in pork has not been touched.

Ricardo Rosselló, who is running in the opposition New Progressive Party primary for governor in 2016, told me in a telephone interview last week that “the debt is only unsustainable if we continue on the same path we have been on.” Writing in Forbes magazine on Oct. 22, Mr. Rosselló noted that the debt is merely a symptom of overspending, “a habit which produces six-billion-dollar deficits per year,” and big government leading to “stunted growth.”

Mr. Colón de Armas emphasizes that there is a difference between budgets and cash flow. But Puerto Rico has long used tax-anticipation revenue notes to meet cash-flow shortfalls. The trouble is that since Mr. García Padilla has spooked lenders, the island has all but lost access to financial markets. The professor maintains that if Puerto Rico would announce tomorrow that it will pay all its debts, as it always has paid them, it would be able to manage its cash flow using short-term borrowing.

There would still be a large budget deficit—but that would reinforce the need to cut expenses. Treasury proposes an independent financial board that would make that happen after the bankruptcy. But why not cut expenses now and avoid savaging bondholders and damaging Puerto Rico’s credit rating?

The answer, as Mr. Colón de Armas says, is that “politicians are trying to avoid the hard work” that they should have been paying attention to as this problem built up over the last decade. But “bondholders don’t vote,” he notes. “People that get fired and people who receive benefits do vote.”

Write to O’Grady@wsj.com.

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