After years of irresponsible fiscal management, Puerto Rico has few good options to address its growing debt crisis. But in most tales of bad behavior, there comes a point where continued punishment for past mistakes becomes counterproductive. We’re reaching that point on Puerto Rico, and the Barack Obama administration has put forward a sensible new approach.
(Citigroup, my employer, has various business relationships with Puerto Rico, including serving as underwriter and market maker in various securities. I’ve had no involvement in those activities, and this column represents my personal views, not those of Citi.)
Puerto Rico’s population and its economy are about 10 percent smaller than they were a decade ago. The poverty rate is 45 percent, only about 40 percent of adults are in the labor force, and unemployment is more than 11 percent.
Given these dire economic indicators, it’s not surprising that Puerto Rico has a serious debt problem. At this point, the territory’s total liabilities amount to more than 160 percent of the economy, and debt service is projected to be more than a third of government revenue. Over the next five years, the fiscal deficit looks to be $28 billion, and although the Puerto Rican government has proposed aggressive policy actions, these could, at best, only cut the deficit in half. Because the territory’s fiscal dynamic is unsustainable, its uninsured debt is selling at discounts of 30 to 70 percent.
Something has to give. Which brings us to the White House’s plan.
The first imperative is to restore economic growth. For this, there are no magic bullets, but one useful strategy is to extend the Earned Income Tax Credit to Puerto Rico. The EITC is one of the most powerful, market-friendly mechanisms for encouraging labor force participation, and its absence in Puerto Rico makes no sense.
The Obama administration also proposes removing an anomaly in the Medicaid system. If Medicaid treated Puerto Rico in the same way as it does the 50 states, the federal government would pay for an estimated 83 percent of its Medicaid costs. But because Medicaid payments to the territory are capped, the federal government has generally paid only 15 to 20 percent. In addition, temporary Medicaid payments enacted as part of the Affordable Care Act are almost exhausted, posing a near-term threat to Puerto Rico’s Medicaid program.
Establishing an EITC in Puerto Rico and adjusting the share of Medicaid payments paid by the federal government make sense from a fairness perspective. The EITC piece would encourage work, and the Medicaid component would attenuate fiscal pressure on the island. These steps would, though, come at a cost to the federal budget, probably in the billions of dollars per year. The administration should clarify both the amounts involved and how they would be financed.
The island’s fiscal governance also needs to be strengthened. Its accounting systems have been shoddy, and revenue estimates have been overly rosy. A period of external oversight is appropriate, to improve transparency and budgetary rigor.
Finally, there’s the hard question of what to do about the existing overhang of debt. Write-offs are inevitable; the only question is how to do them in a structured and timely way. We have bankruptcy laws precisely to handle this sort of situation, which would otherwise involve overlapping negotiations with multiple creditors (Puerto Rico has 18 different debt issuers and 20 creditor committees) and probably extended lawsuits.
At the very least, Congress should extend Chapter 9 bankruptcy laws to Puerto Rico’s cities and public corporations. Municipalities in the states enjoy this protection, and there’s no reason to treat cities in Puerto Rico differently than those in Florida or Texas. This step would cover about a third of the territory’s debt.
The more controversial question, though, is whether Puerto Rico’s government should also have access to bankruptcy protection. State governments do not, but the administration proposes that territories such as Puerto Rico should.
Bankruptcy would not necessarily mean that less debt would be repaid. So it is not clear that the traditional argument against bankruptcy protection — that it would raise future borrowing costs — carries much force. Negotiated write-offs and default would have largely the same effect, but would probably take longer and be messier. Among the options left, the administration’s is the least bad.
The plan requires legislation, and in today’s polarized Congress, that’s a daunting prospect. But as former Treasury Secretary Tim Geithner once emphasized, in a crisis, “plan beats no plan.” the administration has one. Its congressional opponents don’t.
Editor’s Note: this op-ed originally appeared on Bloomberg View.