Puerto Rico has become much more than a vacation destination for anyone who invests their money on Wall Street, plans for retirement using pension funds, or even pays taxes. As the commonwealth continues to suffocate under the weight of nearly $70 billion in outstanding debt, a debate about whether Puerto Rico will become the 51st state has become less about the number of stars on the United States flag and more about the staggering losses facing those exposed to the territory.
While government officials grapple with strategies for addressing Puerto Rico’s massive debt load, they are left paralyzed by the inaction that stems from the fear that a step toward addressing the financial crisis would tip the balance either toward or away from becoming a state.
For evidence of the conundrum you can look no further than the
decision-making related to accepting tax breaks from the continental US
to boost revenue. One of the earliest sparks for Puerto Rico’s
financial demise was lit in 1996, when President Bill Clinton repealed
the legislation that gave tax incentives for US companies to locate
facilities in Puerto Rico.
But because those tax breaks are perceived as a hurdle to statehood,
Puerto Rico Resident Commissioner Pedro Pierluisi – a non-voting member
of Congress and a member of the pro-statehood New Progressive Party –
would not advocate for the return of the aid, even if they could help
balance the budget.
A related wrinkle comes into play as the market debates the benefits
of a federal bailout. Yes, a bailout would be expensive for US
taxpayers; but Puerto Rico’s default could be far more disruptive than
Detroit’s record bankruptcy, experts tell Debtwire.
Lastly, indecisiveness on the issue impacts what could be the most
efficient mechanism to remedy the financial woes. With Puerto Rico being
a territory and not a municipality, it cannot even file for bankruptcy
according to federal law. This means that any type of debt
restructuring would unfold in an uncontrolled way a la Greece or
Argentina.
The statehood stalemate could have a devastating effect on Wall
Street if it also results on a standstill over how to balance the budget
and also keep up with debt obligations.
Puerto Rico and its various public agencies have issued $70 billion of
debt in the tax-exempt municipal bond market, which has been picked up
by state-specific bond funds across America. Today around 70 percent of
US mutual funds own Puerto Rico securities, according to Morningstar.
These funds were looking to increase their yield with the
commonwealth’s bonds, which are exempt from state, local and federal
taxes. As Puerto Rico entered a severe financial crisis and its bonds
were eventually downgraded to “junk” status, prices tanked and investors
have lost as much as 35% of their holdings.
With the territory stuck in limbo, the fact of Puerto Rico’s public
corporations stepped into focus last week when the governor surprised
the market by presenting a last-minute bill that would provide an avenue
for restructuring to public agencies and utilities but not to the
commonwealth itself.