As the Puerto Rican economic recession approached its 10-year mark, the island’s government was preparing to unveil a new budget plan for the 2016 fiscal year. Recognizing the failure of spending cuts from years prior, which contributed to out-migration, unemployment, and a shrinking economy, the Puerto Rican government proposed instead to restore growth through less austere means.
The proposal was dead on arrival.
Puerto Rico’s debt had almost doubled since 2005 and represented a much larger share of personal income than in any U.S. state. And with approximately $74 billion in bond obligations and almost $50 billion in unfunded pensions, the idea of additional budget deficits — even in the short term — was a hard sell. “The fiscal plan attempted to prevent additional cuts to pensions, to the University of Puerto Rico, and to public-sector salaries,” Alejandro García Padilla, former governor of Puerto Rico from 2012 to 2016, told the HPR. “This is why [they] rejected the plan.”
However, this proposal was not turned down by a body of elected officials or by a court. Instead, the plan was rejected by the Financial Oversight and Management Board for Puerto Rico, an unelected commission with almost complete authority over the island’s budget and fiscal policy decisions.
Created by the U.S federal government through the Puerto Rico Oversight, Management, and Economic Stability Act, which aims to “stabilize the island’s economy and provide a pathway for debt repayment,” the oversight board has been in power since 2016. La Junta — as the oversight board is colloquially known in Puerto Rico — resembles the financial management commissions that were temporarily implemented in New York City and Detroit to assist in their respective financial crises. But there is a key difference between these oversight boards and La Junta. While it is true that the members of these municipal oversight boards were not directly elected by the people, they were still appointed by state officials beholden to voters in the cities.
Puerto Ricans face a different reality from those living in the continental United States. Because the seven members of Puerto Rico’s oversight board are appointed by the federal government, where Puerto Ricans have absolutely no representation besides a non-voting delegate to the House of Representatives, La Junta is in no way accountable to the people. Those in charge of Puerto Rico’s finances are beholden only to the White House, Congress, and Wall Street.
Almost 70 years after being granted autonomy under the Estado Libre Asociado, the Commonwealth status arrangement, Puerto Ricans are no longer in control of our own government and internal affairs. And with powers that range from defunding public institutions to preventing government employees from striking, La Junta is a real threat to the self-governance of Boricuas.
Whether the Puerto Rican government’s 2016 fiscal plan would have been efficient is unclear. But the rejection of the government proposal by unelected officials, regardless of its merits, was more than a blow to a policy project. It was a blow to our very democracy — the first of many.
Un Crimen Histórico
For those raised in the island’s decade-long recession and crippling debt crisis, it is hard to imagine Puerto Rico outside of economic freefall. It is all we know. But before the turn of the 21st century, the island was one of the most prosperous economies in the Caribbean. Though considerably poorer than any U.S. state, Puerto Rico achieved a higher per capita gross domestic product than any country in Latin America. It also maintained a notably stable inflation rate through the ’90s.
But much of this growth was heavily tied to legislation that exempted U.S. corporations in Puerto Rico from paying federal taxes. Particularly, a provision in Section 936 of the Internal Revenue Code made such companies eligible for tax credits that effectively rendered operations in the island income-tax free. This made Puerto Rico extremely attractive for manufacturing companies in the pharmaceutical, petrochemical, and technology industries.
While the long-term sustainability of such tax breaks is disputed, there is no question that the policy had a significant impact on Puerto Rico’s economy. According to data from the local government, manufacturing was responsible for roughly 38% of GDP in the ’90s, compared to an average of 19.5% in Latin America and the Caribbean. Moreover, because these companies were encouraged to keep their money in Puerto Rican banks, they provided Puerto Rico with capital that could be used for development.
However, in 1996, this federal corporate credit began to phase out. According to the Government Accountability Office, “the possessions tax credit was criticized [by the federal government] on the grounds that the associated revenue cost was high compared to the employment it generated.” The tax credits also faced some opposition from within the Puerto Rican government. “According to the Uniformity Clause [of the U.S. Constitution], one state cannot have tax benefits that other states lack,” Padilla commented. “So there was this notion [among other Puerto Rican officials] that Section 936 was preventing Puerto Rico from becoming a state.”
The truth is that, even with attractive tax cuts, Puerto Rico had no advantage whatsoever over the states. Although Puerto Ricans have access to Social Security and unemployment insurance, federal funding for many programs is much more restricted. For instance, the regular federal matching assistance percentage for Puerto Rico is set by statute at 55%. Were it calculated in the same way as the assistance percentage for the states, the federal share would be 83%. Residents of Puerto Rico also have limited access to the Earned Income Tax Credit and the Child Tax Credit. As a letter from the Federal Affairs Administration of the Government of Puerto Rico argued, “Although the triple tax-exempt status can be considered a benefit that the federal government grants the territories, its existence is attributable to some extent to the understanding by federal policymakers that the territory is subject to an unfair framework.”
The expiration of Section 936 simply added to that list of disadvantages. In 1995, 440 companies filed for the possessions tax credit; in 2005, the final year of the phaseout period, only 157 did. And as companies left the island in search of more profitable markets, so did the government revenue and the jobs they generated. Manufacturing employment, which had peaked at 159,000 and represented roughly 15% of employment in 1995, fell to 74,000 by 2016. Investment also plummeted by almost 12% from 1999 to 2016.
Puerto Rico’s GDP growth turned negative after 2005, and with the exception of 2012 and 2019, has been negative ever since. To prevent this economic contraction from instantly deteriorating the living conditions of Puerto Ricans, the local government needed to search for a new way to balance its budget — and it needed to do so quickly. Our elected officials would find their easy “solution,” but at the expense of future generations.
La Deuda
Borrowing money to balance budgets and cover recurring costs is a rare practice by states, with many explicitly prohibiting their governments from financing such expenses with debt. However, a mistranslation of Puerto Rico’s Constitution had previously ensured that the local government could issue bonds for precisely this purpose.
The English version of the Puerto Rican Constitution, which was the official document approved by the United States Congress in 1952, holds that the “appropriations made for any fiscal year shall not exceed the total revenue for said fiscal year.” This meant that government spending was not supposed to exceed projected tax revenues. The Spanish version of the Constitution, on the other hand, translates “total revenues” as “recursos totales,” which most accurately stands for “total resources.” This discrepancy allowed Puerto Rico’s Attorney General in 1974 to claim that “total resources” went beyond tax revenues and included proceeds from government bonds.
Now that it was possible to circumvent the balanced-budget clause of the Puerto Rican Constitution, the government was empowered to spend more money than it could realistically earn back. Therefore, when the island fell into recession and public revenue plummeted, government officials decided to simply borrow money to cover gaps in the budget instead of readjusting their financial policy.
It would also not take long for politicians to abuse this loophole for political gain. “The problem was that [the government] issued bonds to keep their campaign promises without attending to the necessities of efficient public administration,” Grace Santana, former director of the Authority for the Financing of Infrastructure, told the HPR. “[They] had these pharaonic construction projects that completely lacked a cost-benefit analysis and whose goals were purely political.”
At the same time, investment in the maintenance of infrastructure was largely neglected until it was too late. “When bonds were issued to fund construction projects, capital was assigned only for their initial construction but not for their maintenance,” Santana explained. “These funds were constantly requested but never granted.” As a result, Puerto Rico’s public infrastructure — including that of the University of Puerto Rico, the Highways and Transportation Authority, and the Aqueducts and Sewers Authority — would gradually deteriorate and subsequently require millions of dollars to rehabilitate.
The most extreme example of this was the Puerto Rico Electric Power Authority, the public corporation that managed all of the energy generation, distribution, and transmission on the island. After decades of neglect, Puerto Rico’s electric grid was near the brink of collapse while production costs skyrocketed. By 2011, the average retail price of electricity in the island was 27.9 cents per kilowatt hour, more than two and a half times the average for the United States. “The system was so dysfunctional that many of its components had exceeded their lifespan, so bonds were issued to artificially lower the price of electricity ahead of the upcoming elections,” Santana commented. “Such measures ignored underlying issues with band-aid fixes that only served to boost politicians’ own chances at reelection.”
But perhaps the biggest mistake by the Puerto Rican government was issuing bonds to cover recurring costs. “It was a criminal irresponsibility,” Juan Dalmau, former Puerto Rico state senator and candidate for governor, told the HPR. “The government was issuing bonds to cover their payrolls and fund public policy without any guarantee that such spending would be sustainable in the long term.” Because bonds were now being used to fund intermittent spending, the very operation of the government became dependent on debt. This created a vicious cycle in which “the government needed to issue more bonds each time the [previous] bonds were consumed,” Dalmau added. The situation was so dire that the Puerto Rico Sales Tax Financing Corporation — called COFINA by its Spanish acronym — was created in 2006 specifically to finance older debt through newly-issued bonds. Effectively, the government would borrow money, at a lower interest rate, in order to pay back previous debt that had been taken at a higher interest rate. But to ensure this lower interest rate, the bonds would be backed by a brand new Tax on Sales and Use of 7%, directly imposing the burden of the debt onto the Puerto Rican people.
“COFINA was imposed by the previous administration because they wanted to keep spending, they refused to stop reckless expenditures. In doing so, they burdened us with a new sales tax,” Luis Fortuño, former governor of Puerto Rico from 2008 to 2012, explained in an interview with the HPR. “And this new sales tax was highly regressive, because it affected poor people the most. Everyone has to go to the store, but those who earn higher incomes are not as affected as those who earn very little.”
In 2015, the Tax on Sales and Use was increased to 11.5%. Despite having a population where 44.1% of its citizens live below the poverty line, Puerto Rico now faces the highest sales tax in the entire United States. “The cost of running a small business in Puerto Rico, and the cost of maintaining a family, has increased significantly for us,” explained Ricardo Molinary, owner of local coffee shop La Criolla, in an interview with the HPR. “In the case of my cafeteria, sales have decreased because Puerto Ricans now have less money in their pocket and [the sales tax] increases prices. And so people cannot cover the same expenses as before.”
“Los Buitres”
There is no doubt that the Puerto Rican government is greatly responsible for the debt crisis, but politicians are just one part of the story. Just like any other security, bonds are subject to the laws of supply and demand. So, while it makes sense why the Puerto Rican government would issue so many bonds, it is not obvious why these would have buyers. After all, aren’t bonds from an indebted government whose economy is in recession a risky investment?
It turns out that the Puerto Rican Constitution contains a provision that forces the local government to pay interest on the public debt before it can use funds for any other purpose. Furthermore, because Congress amended Chapter 9 of federal bankruptcy code in 1984 to exclude Puerto Rico from filing for debt relief, the island lacked a mechanism to restructure its debt. Therefore, even when the economy was in decline and the government already owed billions of dollars, bondholders were nevertheless guaranteed to earn positive returns on their investment. The government would be obligated to pay back its debt, even if it meant draining Puerto Rico dry.
This is how Puerto Rican bonds were able to maintain an Investment Grade rating throughout years of economic turmoil. As far as investors were concerned, the island’s public debt was virtually risk-free. Moreover, payments on the island’s municipal bonds were not subject to federal or state taxes, which made them even more attractive to prospective lenders. “For years, the Puerto Rico Planning Board presented overly optimistic economic forecasts to justify a given budget and these numbers were never reached. But Standard and Poor’s, as well as Moody’s and Fitch all looked the other way,” Padilla commented, referencing firms in charge of evaluating securities. “These rating agencies are as responsible for the financial crisis as the local administrations which issued the debt.”
It took almost a decade after the economic crisis began for Puerto Rican bonds to be finally downgraded below investment-grade. In early 2014, citing concerns over the lack of sufficient liquidity and the use of bonds to finance deficits, three rating agencies demoted the bonds into “Speculative” or “Junk” status — signaling that the bonds were of higher risk. This decision could have also been influenced by Detroit’s bankruptcy a few months prior, which signaled that government bonds were not as risk-free as previously believed.
But even this would not be enough to curb demand altogether. As traditional institutional investors began to worry that Puerto Rico would not pay back its debt, they began to sell their holdings to hedge funds at a steep discount. Unlike traditional bondholders like pension funds, which invest in low-risk and low-return securities, hedge funds invest in securities that offer high absolute profits to a select number of individuals. These nontraditional investors were also attracted by the new Puerto Rican bonds issued after the downgrade, which had increased interest payments to offset the “higher risk” of the Junk Rating. “Before the downgrade, there wasn’t a single hedge fund [investing in Puerto Rican bonds], only institutional investors,” commented Fortuño. “Hedge funds are speculators, but [before the downgrade] there was no speculation with our bonds.”
Conservative estimates suggest that around 24% of all Puerto Rican debt is now owned by hedge funds, though other estimates put that number closer to 50%. The Baupost Group alone, a Boston-based hedge fund managed by billionaire Seth Klarman, owned almost a billion dollars in Puerto Rican bonds as of 2017. By acquiring such a significant share of the island’s debt, these investors would gain a stake in the debt crisis, and grant Wall Street a means to influence Puerto Rico’s future.
La Quiebra
With a deep economic recession, billions in bond obligations, and sharp fiscal deficits year after year, it was clear that Puerto Rico would not be able to pay its debt without collapsing. So in 2015, the local government declared the debt to be unpayable and sought to restructure its liabilities, making Puerto Rico the largest public entity, and the first state government, to seek bankruptcy in the history of the United States. “They expected us to stop providing basic services to pay back the debt … we would have not been able to pay public-sector wages and pensions, we would have had no money to keep our medical center running, no funds to buy fuel for the electric system,” Padilla, who was governor at the time, commented. “They were crazy if they thought I was going to pay Wall Street before paying our nurses.”
This immediately prompted a negative reaction from bondholders and caused turmoil in the credit market, which in turn forced the federal government to get involved. But because Puerto Rico had previously been prohibited from filing for bankruptcy, on top of its complicated political relationship with the United States, the framework to allow Puerto Rico to restructure its debt did not exist. In the chaos, the local government had originally pushed for Congress to amend Chapter 9 of the Bankruptcy Code and once again allow Puerto Rico to restructure its debt under its provisions. However, these efforts were undermined by influential bondholder groups who lobbied the House Judiciary Committee and prevented Congress from seriously considering this option.
Instead, the federal government developed “A Roadmap for Congressional Action to Address the Crisis in Puerto Rico” and designed a restructuring framework catered specifically to their territory. This roadmap led to the drafting of the Puerto Rico Oversight, Management, and Economic Stability Act. This legislation included legal protection against lawsuits and a mechanism to restructure the public debt, the two main provisions requested by the Puerto Rican government.
However, many in Congress were concerned about the credibility of local officials and insisted on imposing stricter fiscal controls on the island — a position which creditors also supported. So PROMESA came with an enormous catch: These provisions, which Puerto Rico desperately needed, would only be granted under the condition that an unelected oversight board was imposed on the island.
“Una Barbaridad Colonial”
PROMESA was signed into law by the federal government in June 2016, and two months later, the seven members of the oversight board were appointed. Tasked with the dual mandate of stabilizing the island’s economy and providing a pathway for debt repayment, La Junta would soon exercise near total control over Puerto Rico’s financial policy.
But it quickly became evident that their legal responsibility to promote economic growth would not be the priority. Facing pressure from creditors, who rejected a restructuring offer as high as 77 cents for every dollar on general obligations and 58 cents for each dollar from sales-tax bonds in 2017, the oversight board instead committed itself to debt repayment by all means. This effectively meant extracting what little wealth Puerto Ricans had in order to appease bondholders in the short term.
All Puerto Ricans have felt these austerity measures in one way or another. “For example, the new labor reforms [approved by the oversight board] eliminated sick days and increased probation periods for new employees,” explained Dalmau. “And the elderly, which are an impoverished and vulnerable sector, could face drastic reductions in their pensions.” Moreover, as a response to the loss of federal subsidies in healthcare, the oversight board has proposed to simply provide less health services in the island.
Retirees have been especially impacted by the policies. Many in this group had already lost most of their savings when the bond market went into turmoil. “There were many Puerto Ricans whose retirement was in Puerto Rican bonds, and these people lost everything they had worked for throughout their whole lives. … It’s a tragedy,” commented Fortuño.
The oversight board’s actions have only added to these grievances. “What [the oversight board] is doing to retirees is an expropriation, a confiscation,” argued Luis Dávila Colón, Puerto Rican attorney and political analyst, in an interview with the HPR. “Retirees are being robbed of 8.5% of their pension, and many of them, like teachers and police officers, lack social security. This is inhumane.”
But while the oversight board has been relentless in defunding the public sector and dismantling the fragile social safety net of the island, it seems to have no problem with the elevated cost of its own operations. Despite being imposed by Congress, La Junta is not part of the federal government and is instead an independent entity within the Puerto Rican government. This means that all of its expenses, which are projected to exceed $1.5 billion in legal and financial advisors fees alone, are covered by Puerto Rican taxpayers. This includes the salary of the oversight board’s executive director, Natalie Jaresko, who earns an annual compensation of $625,000 despite the median household income in Puerto Rico being $20,474. “They are wasting more than a billion dollars in consultants and operational expenses,” explained Dávila Colón. “This is so much money, that those funds would have been enough to cover all pensions for 15 years.”
To be fair, La Junta has seen some success from a fiscal standpoint in terms of debt restructuring. According to their latest fiscal plan, “the restructuring of more than a third of the outstanding debt has already been completed, totaling $27 billion.” Moreover, the Restructuring Support Agreement reduced the Electric Power Authority’s debt by about $2 billion, and liabilities related to COFINA were reduced by roughly $6 billion.
This was certainly no easy feat. However, despite these massive cuts in spending, the long-term financial outlook of Puerto Rico remains quite bleak. La Junta itself projects that, even if they manage to achieve balanced budgets throughout the next decade, the island will once again fall into fiscal deficits from the year 2036 onwards.
Otra Década Perdida
The economic expectations for Puerto Rico are even more concerning than the financial outlook of the public sector. The fiscal plan projects a post-pandemic recovery between the years 2021 and 2022, followed by an average real growth of 0.2% from 2023 and 2029. After 2030, the oversight board projects that the island will return to its historical trend of economic decline.
And this is the best-case scenario under their plan. While the Puerto Rican economy is indeed showing signs of recovery from the pandemic, this has mainly been driven by temporary federal funds that the island has virtually no control over. Furthermore, the report claims that “the extent at which the economic activity will recover from the COVID-19 pandemic impact and the time it will take to return to pre-pandemic levels remain highly uncertain and could prove to be narrower and longer-lasting than anticipated.”
La Junta blames this grim economic forecast on the inability of the local government thus far to take “the transformative steps needed to create the conditions for growth, spur private sector innovation and investments, and improve opportunity and quality of life for residents.” Given the suboptimal track record of Puerto Rican economic policy, this assertion might hold some merit. However, to blame the stagnation of the local economy exclusively on the government is disingenuous.
Throughout the five years that it has been in power, La Junta has actively been an obstacle to the economic growth policies that it claims to support. “The draconian control that the oversight board has over the expenses of my agency has often limited our roadmap to promote investment, generate revenues, and spur economic growth,” explained Manuel Cidre, Secretary of the Department of Economic Development and Commerce, in an interview with the HPR. “We have faced intervention in the incentives we receive to promote economic activity, and experienced limitations in our capacity to hire external consultants to validate our economic plans.”
A significant roadblock to Puerto Rico’s economic recovery is the unreliable and expensive power system on the island. High electricity prices increase the cost of running businesses, make household activities more expensive, and decrease the disposable income of already impoverished communities. So in order to “provide lower cost and more reliable energy, establish an independent and well-funded energy regulator, and [promote] the development of cleaner and lower cost power generation,” the oversight board sought to denationalize the power grid in Puerto Rico. In March of 2020, the oversight board brokered a rushed deal between the Puerto Rico Electric Power Authority and LUMA Energy — a consortium of various firms — to privatize the distribution and transmission of electricity in the island.
Whether the privatization of utilities is efficient or not is ultimately a normative question, and whether electricity in the island should be managed by a firm or by the government has been a topic of debate for decades. But even supporters of privatization are skeptical about the way in which the oversight board handled the denationalization process. “It seems to me that it was a deal that was brokered while we knelt on our knees. When negotiating under a structure that is fundamentally broken, the government saw itself obligated to accept terms that did not necessarily reflect the best interests of the people,” argued Cidre. “Under other circumstances we could have reached an agreement that was a little more inclined to our favor.”
Almost immediately after officially taking over the administration of Puerto Rico’s electric grid in June 2021, LUMA Energy has been mired in controversy. From a cyberattack which shut down its customer portal to the displacement of experienced line workers, the first months of private electricity have been extremely tumultuous. Moreover, independent analysts have estimated that the structure of the contract could lead to electricity prices as high as 30 cents per kilowatt-hour, despite Puerto Rico’s goal to price electricity at 20 cents per kilowatt-hour. Such price hikes would directly contradict the oversight board’s claim that their policies would provide a lower energy cost and would instead further harm the economy.
Meanwhile, no significant progress has been made toward the reparation of the electric grid, and power outages remain commonplace throughout the island. “Without electricity, my cafeteria cannot function properly. I have to turn on our emergency generator almost weekly,” commented Molinary regarding the frequent power outages. “We have a big problem. And of course, the issues with our electricity have been going on for years, but the situation just keeps becoming more difficult.”
Falsas Promesas
Yet the oversight board is much more than just a threat to public services. “The existence of the oversight board undermines the most basic concepts of the vote and representation,” argued Dávila Colón. “When unelected officials can intervene in basically every aspect of Puerto Rican life, our right to be represented in a legislature and to have a vote that is worth something has been violated … basically every aspect of a republican government lies destroyed.”
The problems with PROMESA go beyond the ineffective austerity policies and disastrous economic program of La Junta. Even for the sake of resolving a fiscal crisis, the undermining of Puerto Rico’s already limited autonomy goes against the most basic principles of democracy. “I believe that the oversight board has intervened in areas of policy that are beyond its legal mandate,” commented Cidre. “It started to get involved in issues such as Law 80 [which protects workers from being terminated without justification], and this has only served to drive the political class into turmoil.”
And this lack of true democracy has had tangible consequences for the Puerto Rican people. “[As senator] I led a project to create an office that would serve as a liaison between the deaf community and the Puerto Rican government,” Dalmau commented. “But because the oversight board’s fiscal plan prevented new government entities from being created without defunding other branches of the public sector, the project was vetoed.” La Junta has also used its power over the legislature’s operational budget as leverage to pressure representatives into supporting their policy recommendations.
The Financial Oversight and Management Board for Puerto Rico was created under the authoritarian assumption that an unelected body of officials was intrinsically more efficient than an elected government at solving economic crises. It was believed that, by being relieved from electoral pressures, La Junta would be in a better position to make the “tough decisions” necessary to bring Puerto Rico into a new age of economic prosperity. But Puerto Rico is currently poorer, more unstable, and less democratic than before. “Even now, five years after the oversight board arrived, Puerto Rico has not fully serviced its debt,” commented Dávila Colón. “Instead, Puerto Rico today is poorer than it was in 2015.”
While we cannot absolve the local government from its indisputable role in the Puerto Rican debt crisis, to place the blame exclusively on the island’s public officials misses the larger picture. Our economic recession and fiscal crisis did not occur in a vacuum, they were the result of broken structural conditions that have perpetuated decades of injustice against Puerto Ricans. But since PROMESA ensures that the oversight board must stay in power until the local government can once again access credit markets, this latest stage in the Puerto Rican colonial experiment shows no sign of reaching a conclusion in the short term despite recent progress. In the meantime, the livelihood and rights of more than three million people remain at stake. Either la Junta leaves to pave the way toward fair representation, or Puerto Rican democracy will remain a shadow of the past — assuming that it even existed to begin with.
Image by Eric Ardito is licensed under the Unsplash License.
Data Visualization: Lucy Ding.
