Commonwealth proposes to remediate debt by halting all cash payments

The Working Group for the Fiscal and Economic Recovery of Puerto Rico recently released its second attempt to remediate its cash deficit crisis. The proposal comes after an initial attempt by the governor to dodge any immediate cash payments by promising a long-term pay-off for investors. However, the appeal failed to satisfy bondholders’ return on investment expectations. The Executive Summary released by The Working Group in favor of the “counteroffer” compares these concerns with what Puerto Rico believes will provide the greatest benefit to both the Commonwealth of Puerto Rico and its investors.

The cash crisis has been an extended problem on the island since 2006. The Government Development Bank of Puerto Rico was established in 1942 and assumed the responsibility of guiding the island’s economy through a period of change. Puerto Rico’s economy used to be very heavily agrarian-based, but has recently become more of a service-backed economy—one of the main industries being tourism. The bank states its mission as follows: “To safeguard the fiscal stability of Puerto Rico and promote its competitiveness in order to transform our economy into one of the most developed economies in the world, hence, fostering the social and economic enhancement of our people.”

However, even with the support of the bank, Puerto Rico’s economy continues to struggle to meet bond payment obligations and has led its fiscal advisors to appeal for help.  On April 6, following the Commonwealth Senate’s approval, Gov. Alejandro Garcia Padilla declared a state of emergency, suspending any cash withdrawals from the bank unless proven absolutely necessary for the common welfare of the people.

This suspension includes emergency services such as police patrolling, fire fighting and ambulance responses. If the reason for the withdrawal does not aid the public in such a manner, it will be forbidden.

The moratorium, or prohibition, will expire January 31. Although there is a possibility of a two-month extension, the prospect still only provides a Band-Aid solution to the problem. Officials must find a way to remediate the severe lack of funds while simultaneously devising a plan that fosters future economic growth.

Puerto Rico’s debt is valued at roughly $72 billion and the bank’s cash inventory is only about $562 million. Since a large lump-sum debt payment is payable on May 1 totaling more than $420 million, the executive order was also signed with the intention that it would reduce further lawsuits appeasing for money.

Earlier in the year, Wal-Mart pursued a lawsuit against Puerto Rico in response to certain taxes levied on the retailer that it deemed unconstitutional. In March, a U.S. court settled the dispute by ruling in favor of the retailer, concluding that the government could not rely on taxes to bail itself out of debt.

Padilla and his advisors made the decision to sign the emergency mandate as a testament that the island will not be able to meet halfway on its debts unless other drastic measures are taken.

Unlike the states, the Commonwealth cannot file for Chapter 9 bankruptcy, causing Puerto Rico to assume the task of remediating its fiscal deficit largely on its own. Although Puerto Rican officials await aid from Washington, a divided government results in varying opinions of how the problem should be solved. In the House of Representatives, Republican senators proposed their version of a bill that would oversee the island’s debt restricting through a federal oversight board. The question of whether or not the Commonwealth should be entitled to its own sort of bankruptcy filing is out of the jurisdiction of Congress and must be disputed in the Supreme Court.

For now, the counterproposal provides two options for current bondholders living outside the island, and a third for residents. However, it fails to provide any remedy that would allow investors to break-even on their investment, unless the bond is held for a substantial amount of time in which the economy would hopefully improve.

In total, Puerto Rico is indebted to investors by about $70 billion, but Padilla has made a promise to ensure public safety before declaring the Commonwealth’s debts are paid as seen in the emergency mandate. The struggle surrounding the island’s economy has caused distress among local residents, many of whom now seek work and a more stable economy.

Indebtedness is a widespread problem not just in Puerto Rico, but states as well. However, the way in which Puerto Rico must deal with the situation fluctuates because its aid is somewhat more limited than that which is provided to the states. The way in which either the legislature or the Court handles the situation will have a large impact on the island’s future economic conditions.