The official statement could hardly be drier. But make no mistake, today’s announcement regarding some $58 million in bond payments is arguably the single most momentous decision in Puerto Rico’s legislative history.
Puerto Rico has now officially defaulted on its debts, and no one knows what the consequences are going to be. We do know that the Commonwealth is not allowed to seek any kind of bankruptcy protection to shield its assets from its creditors – despite the fact that Treasury Secretary Jack Lew said just last week that if Puerto Rico had to somehow try to struggle through without being able to file for bankruptcy, the results “would likely be chaotic, protracted, and costly both for Puerto Rico and more broadly for the United States.”
Welcome to costly protracted chaos, I guess.
In general, when a borrower finds itself unable to pay its debts – whether that borrower is an individual citizen, or a huge company like General Motors, or a major city like Detroit – it files for bankruptcy, and a court works everything out. But under current US law, that’s not an option with Puerto Rico.
Narrowly, the result is that Puerto Rico’s creditors are now going to rush to the courthouse, and attempt to seize the government’s assets. They might well be successful.
More broadly, the result is that Puerto Rico can no longer really be considered a democracy run by its citizens. When a country defaults, government of the people, by the people, for the people falls by the wayside, and effective control starts being handed to creditors. We’ve seen this most spectacularly in Greece, where the German finance minister (the lender) has much more power than the Greek finance minister (the borrower). Laws are nearly always written in favor of lenders and creditors, and if you fail to pay your debts when they come due, you will inevitably lose most of your rights to self-determination.
Do the people of Puerto Rico value their schools and their teachers? Would they vote to keep those institutions and individuals well-funded? Their voice no longer matters: what matters now is what is going to end up being imposed on them by courts and creditors. Decisions on everything from tax rates to privatization are now going to end up being made, one way or another, in the judicial system, rather than by the legislature. And you can be quite sure that the creditors are going to be fighting as hard as possible to maximize the amount of money that they receive, while slashing the amount of money being spent domestically.
If you want, you can try to blame hedge fund managers for this state of affairs, but the truth is it’s not their fault. It’s just a function of the way the legal system is set up: debt is issued as a legal contract under certain jurisdictions; creditors are given certain contractual rights in those jurisdictions; and in the event of default, they will fight in court to exercise their rights. No matter who they are.
That’s why default is such a big deal. When you default, you effectively throw yourself on the mercy of entities with no institutional pity. The only job of a bond fund is to make money. Its managers have no mandate to write off their debts in favor of poor Puerto Ricans suffering under harsh recession and drought, even if that were what they personally might want to do. And while the U.S. government supports the introduction of a bankruptcy solution here (don’t hold your breath), the one thing it has clearly ruled out is any direct bailout whereby US taxpayers in general pick up Puerto Rico’s $72 billion tab.
So, if you thought Puerto Rico’s economic plight was bad yesterday, brace yourself: it got much worse today. The island’s government has given up its last chance to get itself out of this mess. Now, it’s all in the hands of heartless bondholders.