Why Puerto Rico and its mess stand alone

A roofless colonial building is overtaken by vegetation in Old San Juan, Puerto Rico.
Alfredo Sosa | The Christian Science Monitor | Getty Images
A roofless colonial building is overtaken by vegetation in Old San Juan, Puerto Rico.

For the past five years, most states have been making steady progress stabilizing budgets hit hard by the Great Recession, rising pension and health-care costs, and tax-weary voters.

Then there's Puerto Rico.

Swamped by a debt load accumulated by years of borrowing to pay its day-to-day expenses, the island commonwealth has recently seen its credit rating slashed to junk status. Credit analysts say that—while some states still face major budget challenges—not one of them is up against anything even close to the fiscal bind facing Puerto Rico.

"Puerto Rico is really in a class by itself," said Laura Porter, head of state credit ratings at Fitch Ratings. "Their challenges are pretty unique to them."

The problem starts with a pile of debt that's roughly 10 times the average level, per capita, for the rest of the states.

"They have over a decade of consecutive operating deficits, and they financed those operating deficits with debt," said David Hitchcock, a credit analyst at Standard & Poor's. "That alone separates Puerto Rico from almost all the states. No states have come close to that."

Puerto Rico's budget pressures have been amplified by a local economy that's been contracting since 2006—a recession that began before the rest of the states and is hanging on far longer. Though it's Caribbean location remains a tourist draw, roughly half the island's economy is based on manufacturing, which has been hit hard by a change in federal tax law that removed some incentives for mainland manufacturers operating there.

Puerto Rican manufacturers are also competing against NAFTA member Mexico for low-cost production but face higher labor costs because they are required to pay U.S. minimum wage, said Hitchcock.

(Read more: Puerto Rico approves measures to manage debt load)

With the unemployment rate well north of 15 percent, the population has been shrinking, further eroding tax receipts. All of which makes comparisons with other sates difficult to make.

To be sure, some mainland states are facing budget pressures of their own. The four states with a "negative" outlook from Fitch—a warning that their ratings could drop a notch in the next year or two—include Connecticut, Illinois, Minnesota and Pennsylvania.

Among the factors that earned states a red flag, all face rising pension and health-care costs. While still manageable, those rising costs are crowding out spending on other programs and services, said Porter.

Higher infrastructure costs—at a time when federal funding for such projects is shrinking—is crimping spending among many mainland states. The imminent depletion of the federal Highway Trust Fund this summer will only increase that pressure.

(Read more: Redemptions force US mutual funds to unload Puerto Rico debt)

Health-care spending is rising for more than just state workers and retirees. As health reform increases enrollments in Medicaid—which is partially state-funded—the longer-term impact is still unclear.

In states under fiscal pressure, budget reform has often been hampered by the same kind of political gridlock that has gripped budget makers in Washington.

"One of the challenges in Illinois has been just an unwillingness to do anything about anything really," said Porter. "It's been just purely political."

Illinois has enacted temporary income tax increases to offset rising costs, but it's unclear whether those hikes will survive past this fall's gubernatorial election. Some 35 other states will elect governors, which could impact tax and spending policies.

The state level budget outlook remains uncertain even in states that have narrowed or closed budget gaps. That's because rising sales and income tax receipts often spark demands for new spending.

"California is the best example of how the situation has been pretty dramatically turned around," said Porter. "Time will tell whether they will continue to be relatively cautious with adding spending back as the revenue comes back."

Borrowing costs remain relatively low, even as interest rates begin to creep higher across the board. Despite widespread investor jitters as Detroit's bankruptcy threatens to inflict heavy losses on the city's bondholders, states have benefited from the fact that they can't file for bankruptcy, according to Porter.

(Read more: Puerto Rico downgrade took 'cojones': Bond pro)

That's one reason even Puerto Rico is able to continue to tap the $3.7 trillion municipal bond market to raise more cash. Last month, the government there announced that it would sell $3.5 billion in fresh debt to investors, paying as much as 9 percent to attract buyers.

Puerto Rican officials recently spelled out the broad outlines of the offering—which promptly received a preliminary rating two notches below investment grade. Ratings agencies are waiting for the full details before issuing final guidance to investors.

Bullish investors point to hopeful signs that the current government has made progress on closing its budget deficits and has announced plans to cut spending further. But there is less evidence of improvement in the outlook for the local economy.

With the highest yield of any major muni bond issuer, the offering is expected to find buyers. But it remains to be seen whether the sale helps Puerto Rico regain its financial footing.

"We should all put our seat belts on and watch what happens here," J.R. Riegler, head of fixed income indices at S&P Dow Jones Indices, told Reuters.

By CNBC's John Schoen. Follow him on Twitter @johnwschoen or email him.