Puerto Rico’s debt crisis: A Lehman moment for the island

As Puerto Rico careens towards a preventable default on its eye watering $73 billion public debt (which is greater than 100 peecent of the island’s GDP), Congress would be wrong to play chicken with the island’s debt crisis.

At least twice in recent memory the game of financial chicken being waged in Washington has had dire economic consequences for the U.S. and the world.  The most recent example is the political brinksmanship over the debt ceiling and so-called fiscal cliff costing the U.S. its AAA credit rating and hurting the dollar’s credibility as the world’s reserve currency.  The second example was in not extending the too big to fail line to include Lehman Brothers leading to the bankruptcy of this systemically important firm.  Lehman’s failure triggered a massive financial panic seizing the credit markets – the very lifeblood of America’s consumer economy.  If household debt was the powder keg and shoddy financial products the fuse, Lehman’s failure was the spark that ignited the financial crisis of 2008.

{mosads}While many argue that Puerto Rico’s debt crisis is largely decoupled from the broader U.S. economy, as an American protectorate and dollar denominated market, allowing the island to default would be tantamount to a Lehman moment but on a national scale.  Neither a state nor an independent nation, Puerto Rico’s financial crisis is a hybrid between a sovereign debt crisis of an independent nation and the “safe” debt of a U.S. municipality, city or state, which bondholders tend to flock to because of historically low default rates and the possibility of orderly debt restructuring enshrined in law.  Financial crises of this variety take a long time to fester and Puerto Rico’s profligacy is the culprit.  Creating a false deadline for when this crisis needs to be resolved while at the same time not granting Puerto Rico debt restructuring rights afforded to the rest of the U.S. would not only hasten the island’s economic collapse, it may bring down the municipal bond market and other parts of the economy with it. 

Complex debt crises that have ballooned over long periods of time, naturally take time to resolve and restructure.  There are no serious calls on the island to default on its debt, notwithstanding the crippling effects the debt burden is having on all facets of Puerto Rican life.  On this point, some creditors are in agreement with Puerto Rican officials in their appeals to Washington to grant Puerto Rico equal rights as other municipalities and states.  Rather than waiting until the 11th hour, as was the case with the national debt ceiling debate, U.S. political leadership has an opportunity to fend off an economic calamity that could have far-reaching Lehman like consequences.  Puerto Rico’s political elite should not go the way of Greece kicking the debt can down the line taking advantage of bondholder’s patience.  Leadership, fortitude and political consensus are needed the likes of which Puerto Rico has not seen to steer the island through this crisis.

Painful economic choices lie ahead.  Puerto Rico has a chance to emerge as a stronger and leaner Caribbean economy.  For debt restructuring to be serious and to not only address the interests of hedge funds, Puerto Rico must consider all options, however unpopular, including the privatization of many of its sclerotic state owned enterprises.  Beginning with the electric power utility, PREPA, would be a wise choice.  PREPA contributes 13percent or $9 billion to the island’s debt burden and the exorbitantly high energy costs that hurt households, businesses and tourists alike.  For Puerto Rico to remain a business and tourism destination in the Caribbean able to compete with 50 years of pent up interest in Cuba, deep reforms are needed once this debt crisis is resolved.  There are promising green shoots in the idea of making Puerto Rico a regional financial hub for the Caribbean and Latin America.  With billionaires like John Paulson calling Puerto Rico home due to its favorable tax code on capital gains, the island’s last chance may rest in the hands of financiers whose paycheck persuasion and lobbyists will make them heard in Washington.

Disparte is the founder and CEO of Risk Cooperative a specialized strategy, risk and capital management firm located in Washington, D.C. He was born and raised in Puerto Rico.


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