World Economy

6 reasons why Puerto Rico slid into financial crisis

Nathan Bomey
Motorists evade a power line post after Hurricane Maria near Santa Elena in Bayamón, Puerto Rico on September 21, 2017.
Pablo Pantoja | Anadolu Agency | Getty Images

Puerto Rico's attempts to slash its massive debts have taken on greater urgency after Hurricane Maria devastated the island, leading to President Trump's comments Tuesday that the U.S. territory's liabilities should be eliminated.

But the island's economic crisis has been long in the making.

Although Maria escalated Puerto Rico's financial chaos into a humanitarian crisis, the island had already been reeling from years of financial missteps and economic struggles.

More from USA Today:
Puerto Ricans say Trump's visit helps recovery but comments are too political
Behind the Story: Reporting from the eye of Hurricane Maria
6 reasons why Puerto Rico slid into financial crisis

"There's no way for Puerto Rico to be able to rebuild, let alone recover, unless the debt is canceled," said Eric LeCompte, executive director of Jubilee USA Network, a religious coalition that's fighting for Puerto Rico debt relief. "Fortunately for Puerto Rico that process is in place."

The process looks a lot like bankruptcy. Puerto Rico, which filed for the equivalent of federal bankruptcy protection in May, owes $74 billion in debts and more than $53 billion in unfunded pensions.

A federal oversight board is aiming to negotiate debt cuts with creditors in a case overseen by U.S. District Court Judge Laura Taylor Swain of the Southern District of New York.

Although Trump's proposal to slash all of Puerto Rico's liabilities may not be financially or politically realistic, it's increasingly likely that financiers and individuals who lent money to Puerto Rico will suffer huge losses as political momentum mounts for action.

"They owe a lot of money to your friends on Wall Street, and we're going to have to wipe that out," Trump told Fox News. "You can say goodbye to that."

After Hurricane Maria obliterated the island's infrastructure, including power and communications, damage estimates range from $40 billion to $80 billion, according to catastrophe risk modelling software company AIR Worldwide.

Bond holders are nervous. The island's general obligation bonds tumbled to an all-time low after Trump's comments, according to Credit Sights.

If Puerto Rico's debts were canceled, a wide range of investors — including mutual funds, pension funds, retirees and individual investors — would face significant losses. Some of those losses could be covered by bond insurance, though most investors would be stuck with red ink.

Lawrence Summers, a former economic adviser to President Obama, backed upTrump's proposal in a series of tweets Wednesday.

"President @realDonaldTrump is right. Puerto Rico's debt should be wiped out," Summers said. "If ever there was a case for a full debt write off, it's Puerto Rico."

@LHSummers: President @realDonaldTrump is right. Puerto Rico's debt should be wiped out.

A spokesperson for the island's oversight board was not immediately available for comment Wednesday.

But the board asked for emergency funds Tuesday in a letter to Congressional leaders, saying that "your immediate and bold assistance is urgently needed to minimize loss of life, support critical emergency response efforts, and provide tools to support the island's recovery."

Puerto Rico's bankruptcy case has been moving at a snail's pace compared to typical bankruptcies. That leaves open the possibility for federal action.

"They were in the very early stages and it hasn't even been established yet if Puerto Rico is eligible to enter the bankruptcy process or if the bankruptcy process created by Congress is legal," Municipal Market Analytics partner Matt Fabian said.

Aid to help ease Puerto Rico's financial crisis could take the form of a change to the federal law governing the case to make it easier for the island to restructure, Fabian said. It could also take the form of federal guarantees on loans to the island, he said.

But "you always have to bet on inaction being the most likely scenario by Congress," he said.

Population loss

Puerto Rico has lost about 10% of its population over the last decade, sparking an economic crisis that worsens by the day.

The exodus of those residents, who are U.S. citizens, to the mainland has deepened the island's revenue crisis, leaving less money to pay for essential services and to repay debts.

With a poverty rate of nearly 50%, the island's population could fall from 3.4 million before the hurricane to 3 million by the end of the year, making the island's debts even more "unpayable," Fabian said.

"The storm is going to accelerate the economic decline of the commonwealth," Fabian said.

Job crisis

In 2006, Congress ended special tax breaks that historically aided the Puerto Rican economy.

The island's job market has been ailing ever since. While the mainland U.S. added millions of jobs following the Great Recession, Puerto Rico never got back on its feet. The island has lost more than 20% of its jobs since 2007.

Before Maria, IHS Markit projected GDP declines of 3.6% and 2.8% in 2017 and 2018, respectively, for Puerto Rico.

"The challenges of generating economic growth and resolving Puerto Rico's debt problems will worsen if the federal government does not approve a major reconstruction package," IHS Markit analysts Paula Diosquez-Rice and Carlos Cardenas said Monday in a research note. "This would increase the migration from the island and generate growing risks of protests and looting."

Lenders enabled the island's debt binge

For years, bond holders extended credit to Puerto Rico, capitalizing on federal, state and municipal tax advantages. But the lending continued well into the 2010s, when the island was careening toward economic chaos.

Like a subprime borrowing that can't afford to pay for a huge mortgage, Puerto Rico was broke — but the credit was provided anyway.

The additional debt compounded the island's crisis.

Bureaucracy made it worse

Puerto Rico's massive government bureaucracy and regulatory structure have been repeatedly cited as barriers to investments and growth.

Long permitting processes and a dilapidated and expensive electrical grid, which collapsed during the hurricane, are among the many factors that have caused investors to shy away.

Pension promises took a toll

After years of promising pensions that the island couldn't afford, retirement funds are about to run dry.

Now pensioners are at risk of significant cuts, which estimates have suggested could range up to 20%.

Federal rules worsened matters

Because of the quirks of budgeting and political implications, Puerto Rico receives proportionately less Medicaid funding than U.S. states.

That has caused the island to take alternative measures, including borrowing, to fund its already underfunded health care system.