Puerto Rico teetered into insolvency Wednesday as the chronically troubled U.S. territory of 3.4 million citizens buckled under its ever-increasing debt, which stands at $73 billion.
The process that Puerto Rico has undertaken is a prelude to bankruptcy, but in this case it is tailored for governments. Given the size of the debt, it would be the largest such insolvency in U.S. history, far outstripping Detroit's $18 billion restructuring in 2013.
"Puerto Rico's problems have been decades in the making," said Michael Williams, the attorney who represented Puerto Rico in its financial crisis litigation until recently. "One can only hope that this filing puts Puerto Rico on the path to a fresh start."
Puerto Rico's situation is not dissimilar to Detroit's, which was the culmination of years of economic stagnation and bad policy. Puerto Rico, an island in the Caribbean that is about the size of Connecticut with half its gross domestic product, needs billions to stimulate its economy and upgrade its infrastructure, including its water and electrical delivery systems as well as waste collection. Both also face massive pension obligations.
A seven-member federal oversight board set Wednesday's events in motion when it filed in U.S. courts to place the territory under protection from a growing avalanche of bondholder lawsuits.
The oversight board was empowered under legislation known as the Puerto Rico Oversight, Management and Economic Stability Act, or PROMESA, to submit a plan to a court with the power to impose a settlement. A bankruptcy judge is expected to be appointed to oversee the process.
Investors had bought the bonds in the belief that Puerto Rico, like U.S. states, would not be allowed to fail and the debt would be protected. But many of the agencies that have issued government debt in Puerto Rico missed payments, putting them in default.
A maze of government-issued bonds through various taxing authorities and revenue streams complicated attempts by Puerto Rico to settle with bondholders.
"The complexity of Puerto Rico's debt, with multiple types of debt and classes of shareholders, make voluntary negotiated settlements more difficult," said Andrew Biggs, a resident scholar at the conservative American Enterprise Institute and a financial oversight board member. "It's possible that the prospect of legal adjudication will put new energy behind a negotiated settlement."
Sergio Marxuach of the Center for a New Economy in Puerto Rico, a left-of-center think tank, said the filing was necessary in light of the torrent of lawsuits the government faced. "There were 18 government agencies who were issuers with different securities, different collateral, with bondholders having interests against each other," he said. "Without an orderly legal process, these negotiations were going to take forever."
Gov. Ricardo Rosselló announced the proceedings Wednesday after his government failed to persuade creditors to accept less than what they are owed.
Some U.S. lawmakers were hopeful. House Natural Resources Committee Chairman Rob Bishop, R-Utah, who led last year's negotiations to create the financial oversight board, said that body must be given space to work: "We've got the pieces in place. I don't want Congress to try to superimpose on top of them and try to micromanage them."
Bishop said Congress should examine what role, if any, it can play in promoting a longer-term economic turnaround on the island. But Bishop urged caution for now. "You can't start a process and then stop it at the very beginning because we don't think it's doing what we want it to do yet," he said. "We've got to let the process play."
Rep. Nydia Velázquez, D-N.Y., who was born and raised in Puerto Rico, said that thanks to the law, the territory has the tools it needs to climb out of its crisis. "It is time for the government and the creditors to move forward in restructuring the public debt," she said.
It is unclear how much will be paid to holders of Puerto Rican government bonds. The territory had planned to cover less than a quarter of the debt that is due over the next 10 years.
A coalition representing a third of Puerto Rico's senior secured bondholders, with $2.5 billion at stake, applauded Rosselló's move, calling it "sound public policy and ... a much-needed step forward on the island's path to restructuring its debts in an orderly manner.
"This was certainly an option of last resort," according to the group, which includes retirees, investors and asset managers such as GoldenTree Asset Management, Merced Capital, Tilden Park Capital Management and Whitebox Advisors. "The move enables Puerto Rico to freeze numerous lawsuits, maintain essential services for its residents, and rely on a court-driven restructuring process to objectively determine respective creditors' rights."
Nader Tavakoli is the former chief executive of Ambac Financial Group, a large insurer of Puerto Rico debt. "A long and drawn-out battle with creditors will be catastrophic for Puerto Rico and its people," he said. "It's difficult to see how Puerto Rico will have access to the large amounts of affordable capital needed to revitalize the island without consensus with its existing creditors."
Unsecured creditors and junior bondholders have taken significant losses in past restructurings, such as in Detroit, and are probably more vulnerable to large losses in Puerto Rico.
"Puerto Rico's bankruptcy is unique in size," Williams said. "But it's not just the size of the problem that is unique. It was the long-standing absence of a legal path for restructuring its debt that contributed to this."
President Barack Obama signed the PROMESA legislation over the summer as the territory's financial situation grew dire and the economic death spiral took hold.
The island territory, 1,500 miles from Washington, saw its population plummet to 3.4 million from more than 5 million. Its economy has withered, its debt has mounted, and the unemployment rate has settled into double digits. The territory's agriculture department suspended subsidies to farmers. Businesses experienced power failures from the state-owned utility. The treasury withheld tax refunds.
Many suppliers, unpaid and unwilling to extend commercial credit, began demanding payment on delivery by a government that owes them a total of $2 billion.
One building contractor who was owed more than $1 million received two payments from the Government Development Bank for a total of $164,030 — only to see them bounce.
The rescue plan involving the oversight board was fraught with politics as it wound its way through Congress last year. Some politicians used politically charged language to describe the plan.
One group, the Center for Individual Freedom, spent millions on ads calling the Puerto Rico bill a "bailout," targeting congressional districts. As Jeff Mazzella, the group's president, sees it, the oversight board's action "will allow Puerto Rico to rob millions of American retirees and savers who invested in Puerto Rico bonds."
"Furthermore," he said, "it cements the political precedent set by Congress for high-spending states with unsustainable debts to ultimately follow suit."