Puerto Rico must escape the debt trap

30 November 2015 by Pierre Gottiniaux

Puerto Rico (CC Ricymar Photography)

Since the end of the 19th century Puerto Rico has been some sort of unacknowledged US colony. Officially its few islands are called a ‘non incorporated territory’ with Commonwealth status, i.e. the status of a sovereign state but with limited scope of action. The Puerto Rican legal system was thoroughly remodelled by the US to suit their purposes. US courts cancelled the law on state bankruptcy, though it figures in all so-called economies, including that of the US. However, this law would be most useful to the government of this country, who have acknowledged that the Puerto Rican debt is impossible to repay.

Where does the debt come from?
Puerto Rico’s privileged status provides a number of measures such as tax exemptions for US investors and tax exemptions on interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. paid on Puerto Rican debt securities. This makes Puerto Rico some sort of tax haven Tax haven A territory characterized by the following five independent criteria:
(a) opacity (via bank secrecy or another mechanism such as trusts);
(b) low taxes, sometimes as low as zero for non-residents;
(c) easy regulations permitting the creation of front companies and no necessity for these companies to have a real activity on the territory;
(d) lack of cooperation with the inland revenue, customs and/or judicial departments of other countries;
(e) weak or non-existent financial regulation. Switzerland, the City of London and Luxembourg receive the majority of the capital placed in tax havens. Others exist, of course, such as the Cayman Islands, the Channel Islands, Hong Kong and other exotic locations.
. Who would not like to live there, you may wonder!

On the other hand, since Puerto Rico is not quite one the US states, investing in its debt securities may not be as safe. Consequently interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
are much higher, between 8 and 10%. For investors, this is the Promised Land! Just imagine: they garner (at least) 8% tax-free, and to top it all, Puerto Rican laws state that paying interest has to prevail over any other public expenditure! It was not long before capital holders were offering successive governments billions of dollars in loans– those in power would surely find something to do with all this money! And sure enough, the governments accepted. If you stick a carrot in front of a donkey, it is unlikely to ask what you want in exchange.

Increased dependence on the markets

When the 2007 ‘crisis’ broke out, the State’s revenues plummeted, which resulted in a significant contraction of economic activity, and an increase in fiscal deficit. Puerto Rico then had to borrow more from the financial markets thus increasing the hold of public debt.

When Detroit filed for bankruptcy in 2013, it had unexpected collateral Collateral Transferable assets or a guarantee serving as security against the repayment of a loan, should the borrower default. consequences for Puerto Rico. Suddenly investors looking to invest in US public bodies started to turn away from them, probably considering that if the government had started worrying about its over-indebted cities, this was not good for business. Puerto Rico then found it hard to get people to buy its securities and had to borrow from the banks at even high interest rates.

Finding that something was obviously amiss might have led the government to do some constructive thinking, but instead they concluded that such unsustainable levels of debt must be due to excessive public expenditure, as it had been in Greece and most other countries in the world. So they did what they’d done in Greece and most other countries in the world, they implemented austerity policies! The results have been staggering: about 60% of the adult population are unemployed, 45% of the population live under the poverty threshold (56% of children are affected), over 150 public schools are closed, income discrepancies are higher than in any other US state and emigration jumped from some ten thousand a year before 2010 to an average of 48,000 a year between 2010 and 2014. And public debt continues to increase, as in Greece and most other countries in the world (what a surprise…).

Now Puerto Rico is facing strong pressure from its creditors, for it is short of liquidities Liquidities The capital an economy or company has available at a given point in time. A lack of liquidities can force a company into liquidation and an economy into recession. to meet its next maturities (as in Gr.... well I think you have got the hang of it, haven’t you?). The Puerto Rican debt now amounts to $73 billion, of which 18 billion to be paid by 2020 |1|. The country already defaulted last August |2| on a payment of $58 million. On 1 December, $355 million are to be paid, with another $330 million on 1 January, and Moody’s rating agency Rating agency
Rating agencies
Rating agencies, or credit-rating agencies, evaluate creditworthiness.  This includes the creditworthiness of corporations, nonprofit organizations and governments, as well as ‘securitized assets’ – which are assets that are bundled together and sold, to investors, as security.  Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organization will be able to repay both the principal and interest as they become due.  Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc.  A rating of BB or below is considered a ‘junk bond’ because it is likely to default.  Many factors go into the assignment of ratings, including the profitability of the organization and its total indebtedness.  The three largest credit rating agencies are Moody’s, Standard & Poor’s and Fitch Ratings (FT).

Moody’s : https://www.fitchratings.com/
already predicts another default |3|. The government may not be feeling very festive at this New Year.

Default, bankruptcy or austerity...

Governor Alejandro Garcia Padilla has asked creditors for a restructuring of Puerto Rico’s debt, claiming that if he has to he’d rather default than suspend basic social services for the island’s 3.5 million inhabitants. But little Puerto Rico will have to be extra astute in front of its powerful creditors. It risks ending up in court with lawsuits from malicious creditors, notably the vulture funds Vulture funds
Vulture fund
Investment funds who buy, on the secondary markets and at a significant discount, bonds once emitted by countries that are having repayment difficulties, from investors who prefer to cut their losses and take what price they can get in order to unload the risk from their books. The Vulture Funds then pursue the issuing country for the full amount of the debt they have purchased, not hesitating to seek decisions before, usually, British or US courts where the law is favourable to creditors.
that are already manoeuvring to buy Puerto Rican securities, anticipating a restructuring which they know how to take advantage of. |4|

The Obama Administration, in all their benevolence, suggest that Puerto Rico should use a text that makes for the organized bankruptcy of a US public utility, thus protecting it against its creditors, as was the case for Detroit. An oversight commission would supervise the fiscal reforms Puerto Rico ‘needs’ to face its massive public debt: closing more public schools, further cuts in health care expenditures, in wages and pensions.

Is there no other way?

The Obama plan does not allow for the island’s economic recovery, which will be choked to death by austerity policies, which are patently counterproductive. Similarly, a restructuring that would have Puerto Rico officials sitting side by side with their creditors at the negotiation table would stand little chance of a positive outcome for the island’s inhabitants. The only efficient measure known to date but hardly ever mentioned in the media is to overturn the power relationship between the government and its creditors by suspending repayment of the debt and undertaking an integral audit of Puerto Rico’s external public debt, in order to determine what part of the debt has to be repaid and what part can be said to be illegitimate, illegal, odious or unsustainable and thus has to be cancelled. Excessive interest rates and the island’s colonial status are two first trails to be explored.

This is part of Bernie Sanders’s proposal, the contestant for Democrat nomination who disturbs the US political playing field. |5| In his letter to US Secretary of the Treasury Jacob Lew, Bernie Sanders urges the Administration to ‘convene a meeting ... with the government of Puerto Rico, key elected officials, its major creditors, labor unions, business lenders and pension advocates to work out a debt repayment plan that is fair to all sides’. He is clearly against more austerity and points out that it is ‘impossible to get blood out of a stone’. Better still the Democrat contestant asks for an audit of Puerto Rico’s debt before any restructuring, adding that any ‘debt issued to creditors in violation of Puerto Rico’s constitution must be set aside’... This may seem a rather light recommendation, but coming from a US representative it is already a huge step forward. Bernie Sanders finally requests that Puerto Rico be ‘afforded the same bankruptcy protections that exist for municipalities and public utilities’, and that the inhabitants of the island, who pay the same social security taxes be provided with the same social and healthcare cover as US citizens in the 50 federal states, whereas now they only receive about half those healthcare provisions, which the candidate sees as discrimination. While he is obviously right on this last point, we have seen in Detroit that the bankruptcy protections did not prevent creditors from exacting terrible austerity measures. So it hardly seems sufficient. Carrying out an integral debt audit with suspension of payment should yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. lasting relief for the Puerto Rican economy. If the audit was accompanied by social measures aiming at creating jobs, improving healthcare and the education system, fighting poverty and thus emigration, Puerto Rico would soon be rid of the burden of its debt.

The major US media, as capitalism’s loyal watchdogs guarding their spheres of influence as they would a flock of sheep, are waving ghastly threats of doom and gloom in Puerto Rico’s direction. For instance the New York Times states that ‘a default on its debts would most likely leave the island, its creditors and its residents in a legal and financial limbo that . . . could take years to sort out’ (28 June 2015). This falls just short of claiming that Puerto Rico is about to collapse into an abyss after a frightful tornado or an unprecedented tsunami or an attack by man-eating zombie gulls (which might raise Hollywood’s outrage at thus giving away the end of the movie). Unfortunately, it is just as unrealistic to think that the government might take another road than that of Holy Austerity. Recent history has shown that without massive mobilizations as in Ecuador or Iceland, it is impossible to escape the distorted logics of creditors and abetting governments.

Translated by Vicki Briault & Christine Pagnoulle


|1| http://www.latribune.fr/economie/in...

|2| http://www.latribune.fr/economie/in...

|3| http://www.reuters.com/article/2015...

|4| http://www.nytimes.com/2015/11/05/b...

|5| One of his latest televised debates had an unexpected side effect: requests on search engines for the word ‘socialism’ just exploded before and after the debate.


Pierre Gottiniaux

CADTM Belgium

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