The US territory of Puerto Rico is the oldest colony in the world. Part of the United States since 1898, the Caribbean island with a predominantly Spanish-speaking population of over 3.7 million has often been promoted as a candidate to become the nation’s 51st state.
But May 3, 2017 marked the beginning of a new era for the island, coming over 523 years after being discovered by Christopher Columbus during his second expedition to the New World, as Puerto Rico’s territorial government filed for bankruptcy, just over one year after it first defaulted on paying its debts, and nearly 10 months after it began defaulting on its constitutionally guaranteed debt. Reuters describes the magnitude of the event and what finally touched it off:
Puerto Rico announced a historic restructuring of its public debt on Wednesday, touching off what may be the biggest bankruptcy ever in the .8 trillion US municipal bond market.
While it was not immediately clear just how much of Puerto Rico’s billion of debt would be included in the bankruptcy filing, the case is sure to dwarf Detroit’s insolvency in 2013.
The move comes a day after several major creditors sued Puerto Rico over defaults [of] its bonds.
The government of Puerto Rico’s day of reckoning had been delayed for a year after it first began defaulting on paying back its credit because of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which President Obama signed into law on June 29, 2016. From that time, the territorial government had until May 1, 2017 to negotiate settlements with its creditors, primarily hedge and pension funds, who had been enticed to loan money to Puerto Rico because of high interest rates and the territorial government’s constitutional guarantee to pay back money it borrowed.
When that deadline passed without deals to either settle the claims of its creditors or sufficient tax revenue to make payments on its debt, the future of Puerto Rico in US bankruptcy court was all but assured, as the PROMESA law made it possible for the first time for a US territory or state to file for bankruptcy protection from its creditors.
In this case, the law allows the government to force the restructuring of its debts under Title III of the US bankruptcy code, much like the kind of bankruptcies that have been filed by smaller units of government such as cities and counties.
With filing for bankruptcy now an option and Puerto Rico taking the lead in setting the legal precedents for the equivalent of state-level governments, there’s some interesting speculation on which US state might be the next to seriously pursue the option. Analyst Mike Shedlock makes the case for Illinois to be next, given that state’s completely dysfunctional legislature combined with its enormous public employee pension liabilities.
Meanwhile, accounting firm PriceWaterhouseCooper includes Massachusetts, Connecticut, Kentucky and New Jersey along with Illinois at the bottom of its listing of the relative financial strength of the states, but notes that Puerto Rico would be “ranked last by a wide margin”. Meanwhile, Eileen Norcross and Olivia Gonzales of the nonprofit Mercatus Center place the same five states at the bottom of their 2016 rankings of US states by their government’s fiscal condition, giving the following reasons:
Kentucky, Illinois, New Jersey, Massachusetts, and Connecticut rank in the bottom five states, largely owing to the low amounts of cash they have on hand and their large debt obligations.
- Each state has massive debt obligations. Each of the bottom five states exhibits serious signs of fiscal distress. Though their economies may be stronger than Puerto Rico’s, allowing them to better navigate fiscal crises, their large liabilities still raise serious concerns.
- Unfunded liabilities continue to be a problem. High deficits and debt obligations in the forms of unfunded pensions and healthcare benefits continue to drive each state into fiscal peril. Each holds tens, if not hundreds, of billions of dollars in unfunded liabilities—constituting a significant risk to taxpayers in both the short and the long term.
- The bottom five states have changed since last year. Kentucky’s position has declined, placing it in the bottom five this year. New York is no longer in the bottom five. New Jersey and Illinois improved slightly, but remain in the bottom five. Connecticut and Massachusetts also remain in the bottom five, in slightly worse positions than last year.
Of these states, Connecticut might the most likely to provide serious competition to Illinois in the unofficial race to be the next state-level government to file for bankruptcy, given the breaking news that its highly progressive income taxes are failing to deliver anticipated revenues to that fiscally-strained state government.
Which state would you predict will be the next to head to US federal bankruptcy court?
Authored by Craig Eyermann