Bernie Sanders on Puerto Rico’s Financial Crisis

Puerto Rico is currently facing an ongoing financial crisis where it owes upwards of $70 billion in debt. This has crippled the U.S. protectorate leading to widespread poverty, population decline, and huge potential losses on previous investments. Bernie Sanders believes the U.S. has an obligation to help Puerto Rico with its ongoing financial crisis by allowing it to declare bankruptcy. This would allow Puerto Rico to receive the protections that U.S. states enjoy while it restructures its debt.

Bernie wrote a letter to Treasury Secretary Jack Lew on October 21, 2015 calling for the following:

  • No more austerity:  “The economic situation in Puerto Rico will not improve by eliminating more public schools, slashing pensions, laying off workers, and allowing corporations to pay starvation wages by suspending the minimum wage and relaxing labor laws.”
  • Audit the debt:  “[T]here needs to be an independent and transparent audit of Puerto Rico’s debt… [I]f any debt was issued to creditors in violation of Puerto Rico’s constitution, it must be immediately set aside.”
  • Bankruptcy protection:  “Puerto Rico must be given the same authority granted to every state in this country to restructure the debt of public utilities and municipalities under the supervision of a bankruptcy court.”
  • Healthcare justice:  “Today, the people of Puerto Rico pay the same Medicare and Social Security taxes as we do, but they only get about half the rate of federal health care dollars… That is unacceptable. The federal government should not be discriminating against the people of Puerto Rico by providing much lower Medicare and Medicaid reimbursement rates. [They] are American citizens. They deserve equal rates.”

Here is the full letter.

The Jones-Shafroth Act & Municipal Bonds

What is the the Jones-Shafroth Act?

Puerto Rico became a U.S. territory, or protectorate, in 1898 after the Spanish-American War. However, the inhabitants of Puerto Rico were not granted American citizenship until 1917, when the Jones-Shafroth Act was passed. This law also established a Puerto Rican Senate, bill of rights, and the position of Resident Commissioner to be elected every four years. The Resident Commissioner is the only non-voting member of the U.S. House of Representatives.

Finally, the law also established a “triple tax exemption” for bonds issued by Puerto Rico even for non-resident investors. The Jones-Shafroth Act granted Puerto Rico the freedom to self-govern and regulate its finances mostly independently of the U.S. federal government. Even as Puerto Rico enjoys this autonomy, the U.S. provides protections and many of the privileges enjoyed by mainland citizens to Puerto Ricans. Furthermore, the “triple tax exemption” clause serves as a very attractive option for people all over the U.S. to buy these municipal bonds — not just Puerto Rico’s residents.

Can you tell me how bonds work before going any further?

Sure! Government-issued bonds are one way federal and state governments are able to collect money to finance their debts while continuing to maintain necessary operations and ongoing programs. When a person buys a bond, the government immediately uses the money collected to finance its debt and other projects. Then, once the bond matures, the government repays the individual the principal amount with interest, called the coupon.

The money that you collect as an individual from bonds can be considered taxable income, but is often tax-exempt. Municipal bonds are always exempt from federal taxes, but are still subject to state and local taxes unless you buy them from your own state. That is to say, if you are a resident of California and you invest in a New York municipal bond, then when your bond matures, you must pay state and local tax on your return according to New York’s rate. But if you live in New York when you collect the money, you don’t surrender any tax at all — hence “triple tax exempt”.

So what makes the bonds that Puerto Rico issues more attractive?

The special thing about these Puerto Rican municipal bonds is that they are triple tax exempt even if you don’t reside in Puerto Rico. Thus, investors’ collected coupon is unaffected even if they buy the Puerto Rican bonds elsewhere. This provides a huge incentive for people to buy them, especially those from states with high tax rates.

This triple tax exemption was initially designed — in that same 1917 bill — to increase investment in Puerto Rico’s economy. The large influx of capital was supposed to create stable infrastructure, higher education programs, and social safety. Concurrently, federal tax breaks were established for business operations in Puerto Rico by a 1921 amendment to the U.S. federal tax code, to encourage a thriving industrial environment.

That seems like a solid plan. What went wrong?

Remember that the Jones-Shafroth Act awarded Puerto Rico its own government. Over time, this quasi-independent government tried to pay off its existing debt by selling even more bonds to earn more money. However, this created even more debt.

Similarly, many businesses grew accustomed to the economic advantages provided to them by federal tax breaks. In 1996, however, Congress started phasing out these tax advantages. By 2006, they were completely gone.

Since businesses no longer maintained a competitive advantage, they started leaving the island en masse. Puerto Rico’s spending, however, remained the same even with the mass exodus of industry and investment. The combined effects of these two issues has led to the massive debt Puerto Rico now holds.

Puerto_Rico_Has_No_Easy_Path_Out_of_Debt_Crisis_-_WSJ

Even more troubling is that since the start of its economic decline in 2006, more and more people have been fleeing Puerto Rico’s deteriorating economy. This leaves the burden of the increasing debt on a smaller number of people and businesses who are unable to handle it. Right now, the territory owes more than $70 billion, but its population has been steadily declining at an average rate of one percent annually for the past decade. As of June 2015, Governor Alejandro García Padilla declared that this sum is unpayable.

Debt Renegotiation Options

Sounds like a dire situation – what are Puerto Rico’s options to get out of debt?

There are four general ways this crisis could be resolved.

  • Federal Bailout: The U.S. Treasury could, in theory, absolve all of Puerto Rico’s debt without consequences. This places the burden of debt entirely on the Treasury. However, the Treasury has already refused a bailout.
  • Austerity Measures: Often referred to as an austerity-and-tax reform package, this strategy would impose drastic cuts to social spending forcing Puerto Rico to spend its money repaying its creditors before it can regain its government programs. This places the burden of debt completely on Puerto Rico’s government and the money it collects from Puerto Rican citizens.
  • Declare Independence: Puerto Rico could declare independence from the United States. This would allow Puerto Rico to deal with its own debt without pressure from the U.S. However, by doing so, it would also cut off any support provided by the U.S. Treasury and force creditors to accept large financial losses, setting it off on a bad start as a new nation.
  • Declare Bankruptcy: Currently, all 50 states can declare “Chapter 9” bankruptcy. This strategy offers some legal protections to a state while it tries to get back on its feet, without imposing major cuts to pervasive government programs. This shares the burden of debt among Puerto Rico’s government and the federal government and Puerto Rico’s creditors. The problem, however, is that Puerto Rico isn’t a state and doesn’t have the right to this declaration.

What are austerity measures and how are they enforced?

Austerity measures are sometimes enforced as a way for a country to raise money to pull itself out of crippling debt. They usually involve raising taxes and cutting spending in an extreme manner, which forces countries into a state of harsh social and economic discipline until they are able to pay off everything they owe.

This kind of state prevents a country’s creditors from having to accept losses on their investments. Unsurprisingly, this strategy — which is focused on paying back Puerto Rico’s creditors in full — is advocated by its main creditors.

That makes sense. Why should Puerto Rico’s creditors have to pay for its debt?

Although it may be unfair to force creditors to help out with a problem that they did not cause, the IMF has determined forcing austerity measures will not allow Puerto Rico to raise enough money to pay back its growing debt. Right now the territory is suffering from rampant poverty.

To make matters worse, some creditors are profiting from the pain inflicted on its citizens by its debt. Austerity would only allow these creditors to keep exploiting Puerto Rican citizens while offering no long term stability.

How would Puerto Rican independence help?

Others believe the best solution to Puerto Rico’s economic crisis would be for it to declare independence as a sovereign nation. While causing a large amount of investment loss to creditors, this solution would allow the U.S. to wash its hands clean of Puerto Rico and let it deal with its economic problems on its own.

However, this course of action would be almost impossible. Besides the fact that Puerto Rico has unsuccessfully bid for independence in the past, many residents would prefer statehood, including Resident Commissioner Pedro Pierluisi. He argues that granting Puerto Rico statehood would allow the territory to deal with its economic crisis much more effectively because of the additional rights and resources it would gain as a sovereign municipality of the U.S. Nevertheless, Puerto Rico’s status remains a contentious issue with a nebulous future.

What is Chapter 9 bankruptcy?

Chapter 9 bankruptcy allows U.S. municipalities who are facing extreme economic hardship to restructure their debts in a more manageable way. Puerto Rico would like to declare Chapter 9, but is not legally allowed to because it is a territory, not a state.

Furthermore, Congress has so far decided against making an exception for Puerto Rico. This is one of the reasons Resident Commissioner Pierluisi has been fighting for state designation.

How is letting Puerto Rico file for bankruptcy different from letting them off scot-free? Shouldn’t they have to live with the consequences of their debt?

Remember that allowing Puerto Rico the rights to Chapter 9 bankruptcy is not nearly the same as instituting a federal bailout. Right now, the territory is already living with numerous consequences — it is extremely poor and filing for bankruptcy doesn’t mean all their economic issues would go away.

What’s Bernie’s position on the Puerto Rican economic crisis?

Bernie believes that, instead of punishing Puerto Ricans further or absolving them completely, we should try to rehabilitate their economy. In Bernie’s view, rehabilitation involves sharing some of the burden of their questionable decisions while instituting positive government spending reforms in the future. He explained his stance in his official statement on this crisis:

“I strongly believe Puerto Rico should be afforded the same bankruptcy protections that exist for municipalities across the United States.  We need to do everything we can to allow Puerto Rico to restructure its debt in a rational way that does not harm its people, ordinary investors or pension funds in the United States. Chapter 9 protections would be a good first step. But we also should recognize that the reason Puerto Rico has such unsustainable debt has everything to do with the policies of austerity and the greed of large financial institutions.  Puerto Rico has been in a severe recession for almost a decade. Today, more than 45 percent of the people in Puerto Rico are living in poverty, the childhood poverty rate is greater than 56 percent and real unemployment is much too high.”

How does Bernie propose to enact this type of financial rehabilitation?

Bernie has cosponsored a bill, the Puerto Rico Chapter 9 Uniformity Act, introduced in mid-July 2015, that would give Puerto Rico the same Chapter 9 provisions available to U.S. states. This would allow Puerto Rico to strike a deal with its creditors to reduce and postpone payments. Creditors would suffer proportionally minor losses on their loans while Puerto Rico’s government would be required to pay back a large portion of its debt.

Bernie has said:

“Our goal must be not only to give Puerto Rico the flexibility it needs to restructure its debt, but to make sure that it can rebuild its economy, create good-paying jobs and expand its tax base.”

What’s the latest news?

In August 2015, the island announced that it was defaulting on a $58 billion bond payment. Though it paid the interest — $628,000 — Puerto Rico said it didn’t have the funds to pay out the debt, driving even more concerns about the U.S. protectorate’s liquidity.

Is this like what’s happening in Greece, except in America’s backyard?

Not quite. Nobel Prize-winning economist Paul Krugman explains the difference in detail here, though he does note that one major lesson is that, like in Greece, “too much austerity can be self-defeating.” Krugman summarizes the situation in Puerto Rico by pointing out that it is “well short of utter disaster”:

“It would, in particular, be a terrible idea to give the hedge funds that have scooped up much of Puerto Rico’s debt what they want — basically to destroy the island’s education system in the name of fiscal responsibility. Overall, however, the Puerto Rican story is one of bad times that fall well short of utter disaster. And the saving grace in this situation is big government — a federal system that provides a crucial safety net for American citizens in times of need, wherever they happen to live.”

This view is in line with Bernie’s opinion that Puerto Rico is in a position where it cannot pay all its debt due to “the policies of austerity and the greed of large financial institutions.”

Learn more about Bernie’s stances on both Greece and Financial Regulation.