In default, Puerto Rico faces ongoing fiscal pain

Alvin Baez | Reuters

Debris is scattered around the government housing project Puerta de Tierra which is undergoing renovation work, in San Juan, December 2, 2015.

Like a homeowner with too big a mortgage, Puerto Rico has finally started falling behind on its payments.

And it doesn't look like there's an easy way to refinance its huge pile of debt to make it more affordable.

Gov. Alejandro Garcia Padilla announced Wednesday that the Caribbean island territory will be able to make most — but not all — of the nearly $1 billion in interest payments due Jan. 4. He told reporters he plans to meet with bondholders in early January.

The down-to-the-wire negotiations over just which bondholders will get paid centered on a haphazard juggling act that saw the commonwealth shuffling funds from one account to another to pay its debts. That "clawback" process will likely be the subject of a series of lawsuits from investors who won't get paid what they're legally owed.

While the short-term crisis has been building for years, the long-term outlook remains grim.

All state and local government finances got hammered by the Great Recession. But most of the 50 states have seen their revenues recover and their local economies have bounced back as more taxpayers returned to work.

Puerto Rico's economy, though, continues to struggle, the result in part of the elimination in 2006 of a favorable tax break for U.S. companies that sent many of them packing. Since then, a long-running recession has sparked an exodus of companies and skilled workers.

The economic decline also follows a major borrowing spree that has left the island with a debt pile that dwarfs any of the 50 states relative to its ability to pay.

For fiscal 2014, the latest data available for state-by-state comparisons, Puerto Rico's total public debt outstanding topped $70 billion that outstrips its annual economic output. By comparison, the next most heavily burdened state, Rhode Island, had a debt-to-GSP ratio of 19 percent. Nebraska had the lowest, with a ratio of just 2 percent.

That's left Puerto Rico with a crushing interest payment — more than 8 cents of every dollar of revenue — that is squeezing out funds for other local services.

At Wednesday's press conference, Garcia Padilla would not rule out further cuts in government services.

"We have to do all we can to avoid that situation," he said.

On top of the painfully high level of debt-service costs, Puerto Rico's revenues are being squeezed by high employment that cut into its tax base. Puerto Rico's jobless rate is currently at 12.5 percent — more than double the national average of 5 percent.

Commonwealth officials have called on Congress to act, but it's not clear what form that help would take. One immediate task is to set up a better mechanism for sorting through the fiscal mess and develop a long-term debt repayment plan.

"This increasingly urgent situation demands swift Congressional action to give Puerto Rico access to an orderly restructuring regime paired with independent oversight," the Treasury Department said Wednesday in a statement.

While the losses on Puerto Rico's bonds will be widely felt among many mutual bond funds that are found in millions of small investor portfolio's, the default isn't likely to impact the broader $3.7 trillion municipal bond market. That's because the commonwealth's fiscal strains are far worse than even the most cash-strapped of the 50 states.

Even states like Illinois and New Jersey — also struggling to balance their budgets and cope with large debts and underfunded pensions — are on much sounder financial footing, based on the strength of their economies and ability to make interest payments.

That's reflected in the credit ratings currently assigned to state governments.

Illinois, the lowest-rated state, has an A-minus rating, six notches below the top level Triple-A. Puerto Rico's debt rating has been steadily falling for years as its financial position has deteriorated. Its latest rating, in "junk bond" territory at CC, put it a full 19 notches below Triple-A.

The looming default will likely move it down another two notches, to a D rating.