Megan McArdle on the financial plight that Puerto Rico was facing even before the hurricane season began:
… the fact remains that Puerto Rico is not going to be able to pay all of its debts. Prior to the hurricane, the territory had $73 billion in outstanding debt, and a population of 3.4 million people. That’s approximately $21,500 for every man, woman and child on the island – just about enough to buy each of them a brand new Mini Cooper, provided that they don’t insist on the sport package or the heated seats.
Puerto Rico couldn’t afford to buy 3.4 million Mini Coopers before; they certainly can’t now that Maria has washed out so many roads. Even before the hurricane, Puerto Rico’s GDP was around $100 billion, meaning that repaying its debt would consume nearly nine months of everything the island earned. And while there will probably be a brief bump in economic activity as disaster relief funds pour in and the destruction is cleared away, over the long term the hurricane represents a huge setback: businesses destroyed, people killed or injured, funds that could be generating economic growth instead diverted to simply replacing what has been lost.
So whatever President Trump does, or does not do, investors in Puerto Rican bonds are going to have to take a substantial haircut. The problem is, we’re not going to wipe out the debt entirely. And even if we could, it wouldn’t be enough to get Puerto Rico back to economic or fiscal health.
“If it’s that bad,” you may be thinking, “surely we ought to simply wipe out the debt holders? After all, they’re investment professionals. They can afford to take the loss; ordinary Puerto Ricans can’t.” The problem is that most of the folks holding Puerto Rico’s debt aren’t vulture hedge funds sitting on wads of ill-gotten gains; the overwhelming majority of the debt is held by ordinary folks who buy bonds or bond funds. Like, say, your parents. Or maybe you. And also, a lot of Puerto Ricans, who would be hit very hard if the value of their investments were wiped out.
How did Puerto Rico get so deeply into debt? Step forward the federal and Puerto Rican governments to take a bow:
The operations of the Puerto Rico Electric Power Authority, for example, defy belief: It essentially gave unlimited free power to municipalities and government-owned entities, which used it to do things like operate skating rinks in the tropics. Everywhere you look, you see signs of a government struggling to perform basic tasks: collect taxes, maintain the infrastructure, improve the health system. In the jargon of development economists, the island lacks “state capacity”: It is simply unable to exert the amount of power over its operations that we on the mainland mostly take for granted.
But you can’t entirely blame the Puerto Rican government for the state of the underlying economy, which is what had plunged the island into a bankruptcy crisis even before the hurricane. For that you have to look to the federal government, which eliminated a tax break that had given companies incentives to locate in Puerto Rico, and then oversaw a financial crisis that sent them into an even deeper spiral. We also made sure that a relatively poor island was forced to adopt the federal minimum wage, which was too high for the local labor market. That has contributed to the 11.5 percent unemployment rate. And Puerto Rico uses the U.S. dollar, leaving it unable to adjust monetary policy to overcome economic stagnation.
