A Default Passes While a Potential Storm Approaches

On May 1, Puerto Rico defaulted on a $422 million bond payment to little fanfare. Congress now has a brief window to address the commonwealth’s lack of options before a $2 billion payment is due July 1—a default that would likely not pass so quietly.

Puerto Rico’s debt has been growing for years but the current impasse is due to a lack of flexibility in how to address it. While blame for the current situation can be spread across both Washington and San Juan, it has two primary sources. First, in the 1980s Congress revoked Puerto Rico’s ability to use Chapter 9 bankruptcy through an amendment that changed the definition of what governments were and were not covered. The second is Article VI, Section 8 of Puerto Rico’s own Constitution, which requires that interest on debt must be paid before any other appropriations can be made. On Sunday, Puerto Rico paid the interest on the debt due on bonds from the Government Development Bank.

An important payment that was also made Monday was $1.5 million to the general-obligation debt, the bonds that are constitutionally backed. On July 1, the general-obligation debt payment will be $805 million, and an additional $1.2 billion in other debts are due that day. With the U.S. territory projected to be unable to make its July 1 payments, there are fears that appropriations for public services, including hospitals and other emergency services, will be rescinded in order to comply with the Puerto Rican Constitution. This challenge is compounded by Puerto Rico’s exclusion from Chapter 9 bankruptcy, the result of a 1984 law that revoked the commonwealth’s eligibility.

The result is that Puerto Rico is facing a series of “cascading defaults,” according to U.S. Treasury Secretary Jack Lew, with vital public services in the balance and almost no tools available to the government. Lew has urged Congress to act before the July 1 deadline to provide a mechanism for Puerto Rico to restructure its debt and put in place a new financial oversight board. In his efforts to address the crisis, Rep. Rob Bishop, chairman of the Committee on Natural Resources, which has jurisdiction over U.S. territories, is working to develop legislation which would provide a release valve for the immediate crisis while also installing an oversight board to ensure long-term fiscal sustainability. Bishop and the committee’s work is critically urgent since Puerto Rico’s debt payments due on July 1 could result in a shutdown of public services including hospitals and emergency response services in the midst of the Zika outbreak, impact delivery of public utilities, and close schools .  All of these impacts would worsen the island’s already significant out-migration as people move to the mainland U.S. further depleting the tax base from which the government can draw to pay its debts.

As many states grapple with significant public debts and unfunded pension liabilities, Bishop sought to diffuse any speculation that legislation being developed could set a precedent. “Puerto Rico is not a state and any program dealing with it, or any territory, will not impact, nor set precedents for, states or municipalities,” he said in the statement.