Contributor Post Created with Sketch. Puerto Rico’s Bankruptcy: A Test Case for States

 

shutterstock_171180104When Congress overhauled the country’s bankruptcy law in 1984, it added a new section — Chapter 9 — to address municipal bankruptcies. States, however, were not included. Separate from philosophical considerations of state sovereignty, the Constitution (Article I, Section 10) is explicit: “No State shall … pass any … Law impairing the Obligation of Contracts.” The 1984 law explicitly treats Washington, DC and Puerto Rico on par with states for the purposes of bankruptcy law.

So now that Puerto Rico is insolvent, the island’s government is turning to the federal government for help. It passed a law restructuring its $73 billion in debts (it also owes $40 billion in pension obligations), but its creditors successfully sued in federal court to have the law overturned. Recently the US Supreme Court agreed to hear Puerto Rico’s appeal. Meanwhile, Democratic senators have introduced legislation to extend Chapter 9 protection to the island.

Republicans have so far resisted that call, labeling the move a “bailout.” This is hyperbole — creditors, not taxpayers, would take the hit — but the Republicans are correct on the merits. The island’s lenders took measured risks on the basis of the law as it was written; a retroactive rewrite would be both morally wrong and counterproductive. Just as importantly, what got Puerto Rico into trouble was profligacy, and Chapter 9 protection would do nothing to foster reforms. Absent changes to the island’s unsustainable spending and bloated public sector, it would only be a matter of time before Puerto Rico became insolvent again.

If the condition of Puerto Rico’s finances sounds familiar, perhaps that’s because a number of Democrat-dominated states are in the same situation. For years, we have been warned about unsustainable spending and pension obligations in California, New York, Illinois, Connecticut, New Jersey, and others. Not only are these states the biggest debtors, they are also losing population and growing older. Absent spending reform, it is only a matter of time before one or more of them goes bankrupt too.

And then, who will pay the price? Creditors? Pensioners? State employees? Or will it be taxpayers?

So the situation in Puerto Rico bears watching. It can serve as a template for how these claims are resolved — for good, or for ill.

There are 21 comments.

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  1. RabbitHoleRedux Inactive

    Son of Spengler: what got Puerto Rico into trouble was profligacy, and Chapter 9 protection would do nothing to foster reforms. Absent changes to the island’s unsustainable spending and bloated public sector, it would only be a matter of time before Puerto Rico becomes insolvent again.

    Exactly right. And many more abuses including fraudulent claims of disability among able bodied young who don’t have any compunction against stealing from the US taxpayer. That is prevalent there on the island, and I understand it is prevalent here among many precincts as well.

    It’s so ugly. It’s immoral and unsustainable. It has to be corrected.

    Our Congress is afraid to do what they are elected to do. In purposefully avoiding direct action rather than rightfully curbing the abuse, culling gross redundancies in government as a form of welfare, and by avoidance obviating the necessity for required reforms before an election. They know that everyone is watching as you duly noted. I’m just guessing of course.

    • #1
    • January 22, 2016, at 12:21 PM PST
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  2. Dave Sussman Podcaster

    Side note: I’m hearing about a lot of investment opportunities in PR right about now.

    • #2
    • January 22, 2016, at 1:14 PM PST
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  3. Son of Spengler Contributor
    Son of Spengler

    RHR, I only wish everyone were watching. I fear that very few are. And that means the politicians (and perhaps investors) can get away with doing the easy thing rather than the principled thing. Taxpayers beware.

    • #3
    • January 22, 2016, at 1:23 PM PST
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  4. Randy Weivoda Moderator
    Randy WeivodaJoined in the first year of Ricochet Ricochet Charter Member

    Good article, Son of Spengler. If someone is drunk and broke, it’s foolish to pay their bar tab for them thinking that they will have learned their lesson, and will stop drinking tomorrow.

    • #4
    • January 22, 2016, at 2:57 PM PST
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  5. Ward Robles Inactive

    Dark days are ahead for taxpayers in one-party states- depending on which party. The MSM will hide this until the next crisis makes that impossible. Thanks for the update!

    • #5
    • January 22, 2016, at 7:02 PM PST
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  6. The Reticulator Member

    Son of Spengler: And then, who will pay the price? Creditors? Pensioners? State employees? Or will it be taxpayers?

    It doesn’t matter so much for obama (lower-case obama = generic obama) so long as the states and/or Puerto Rico are then beholden to the federal government. I’m pretty sure obama are drooling at the possibilities of doing dozens of bailouts of this kind, because it will work just like with 19th century obama and the American Indians: Get them in debt, then broker a deal by which the creditors get paid (so we can repeat the cycle) and by which the Native peoples give up their possessions and freedom. Later the creditors can be eased out of the picture.

    Here is what Thomas Jefferson obama wrote to William Henry Harrison obama in 1803:

    To promote this disposition to exchange lands, which they have to spare and we want, for necessaries, which we have to spare and they want, we shall push our trading uses, and be glad to see the good and influential individuals among them run in debt, because we observe that when these debts get beyond what the individuals can pay, they become willing to lop them off by a cession of lands.

    You can google for the context if you wish.

    • #6
    • January 22, 2016, at 7:23 PM PST
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  7. Profile Photo Member

    Ward Robles:Dark days are ahead for taxpayers in one-party states- depending on which party. The MSM will hide this until the next crisis makes that impossible. Thanks for the update!

    Good thing Texas and North Dakota are well-diversified economies.

    • #7
    • January 22, 2016, at 9:02 PM PST
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  8. James Of England Moderator
    James Of EnglandJoined in the first year of Ricochet Ricochet Charter Member

    Ward Robles:Dark days are ahead for taxpayers in one-party states- depending on which party. The MSM will hide this until the next crisis makes that impossible. Thanks for the update!

    Just fwiw, Puerto Rico is not a one party state. At the last (2012) election, there was a change in power in both the executive and legislative branches, with the New Progressive Party, which includes some conservatives, despite the name, moving from a decent majority to a small minority; there was also a third party win. It seems plausible to me that the NPP might return to power in November, although obviously it’s too far out to know much now.

    • #8
    • January 23, 2016, at 12:18 AM PST
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  9. Done Contributor

    Brad2971:

    Ward Robles:Dark days are ahead for taxpayers in one-party states- depending on which party. The MSM will hide this until the next crisis makes that impossible. Thanks for the update!

    Good thing Texas and North Dakota are well-diversified economies.

    They have the advantage of politicians who are willing to cut spending in order to make up short falls, as opposed to liberal states who are only capable of making their economies worse in a downturn by raising taxes.

    • #9
    • January 23, 2016, at 1:16 AM PST
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  10. Paul Erickson Inactive

    I am struck by the turnaround. During the Revolutionary War, the congress had no money and Washington had to beg from the states to keep the army fed.

    Now the states may come begging to Washington, but the till is empty.

    • #10
    • January 23, 2016, at 4:02 AM PST
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  11. Son of Spengler Contributor
    Son of Spengler

    Reticulator, you know the Golden Rule: Whoever has the gold makes the rules.

    I do think that it makes philosophical sense that any bankrupt or bailed-out state should be put into receivership. That is, if Feds pony up money, the state loses its sovereign status. Its legislature is disbanded and it gets a governor appointed by Congress. It loses its seats in Congress and its electoral votes. After 10 years, it can reapply for statehood.

    But I doubt that Congress would stick to principle. If PR gets a lifeline without any meaningful conditions, you can be sure that the same will be granted to any bankrupt state.

    • #11
    • January 23, 2016, at 3:05 PM PST
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  12. James Lileks Contributor

    Brad2971: Good thing Texas and North Dakota are well-diversified economies.

    Can’t speak for Texas, but NoDak also has more than oil; there’s edible stuff that grows out of the soil, and people seem to like it. The main big city – relatively speaking – is diverse enough, with finance, health care, education, and so on.

    • #12
    • January 23, 2016, at 4:44 PM PST
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  13. Casey Way Inactive
    Casey WayJoined in the first year of Ricochet Ricochet Charter Member

    SoS, I’ve been thinking about the loss of sovereignty for insolvent states for a while. It would be the best incentive and motivation for states to have their finances in order. Could you imagine how crazy California and the progressives would go if they lost Electoral College votes?

    How do you think that would work practically? Would the federal government set the state(territory ) tax rate? Would it offer tax incentives so businesses do not completely depart and worsen the state economy? Would the territory be designated right to work? In the long term, you would want such a situation to prime a previous state to come back as an economic engine before returning to a local sovereign legislature. Having a plan of the final outcome might make such short term “drastic” actions more palpable.

    • #13
    • January 23, 2016, at 5:44 PM PST
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  14. Son of Spengler Contributor
    Son of Spengler

    Casey Way: How do you think that would work practically? Would the federal government set the state(territory ) tax rate? Would it offer tax incentives so businesses do not completely depart and worsen the state economy? Would the territory be designated right to work? In the long term, you would want such a situation to prime a previous state to come back as an economic engine before returning to a local sovereign legislature. Having a plan of the final outcome might make such short term “drastic” actions more palpable.

    I haven’t done my homework on how it would work in practice. If you have, that might be a great topic for its own post! It deserves close attention.

    The questions you raise about the economic arrangements are critical. Most of these states have spending problems. But if you put public employees out of work, and cut welfare benefits, the short-term economic outlook may worsen (even as the long-term economic outlook improves)….

    And then there are questions as to which public employees you’d keep, out of necessity, and which departments would be shuttered. Which regulations would stay intact and which would be invalidated (certainly the latter category would include the ones enforced by the shuttered departments). My original thinking was modeled on the situation before the western states were admitted to the union, but the questions you raise highlight the fact that today’s states are so much more insinuated into people’s lives that the situation would be much more complicated.

    Regardless we are talking about an ugly, ugly situation. All the more reason to establish incentives NOW for the states to get their acts together.

    • #14
    • January 23, 2016, at 7:38 PM PST
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  15. The Reticulator Member

    Son of Spengler:Reticulator, you know the Golden Rule: Whoever has the gold makes the rules.

    I do think that it makes philosophical sense that any bankrupt or bailed-out state should be put into receivership. That is, if Feds pony up money, the state loses its sovereign status. Its legislature is disbanded and it gets a governor appointed by Congress. It loses its seats in Congress and its electoral votes. After 10 years, it can reapply for statehood.

    But I doubt that Congress would stick to principle. If PR gets a lifeline without any meaningful conditions, you can be sure that the same will be granted to any bankrupt state.

    I would foresee states saying, “No, we don’t need a bailout. We can handle this. We’ll just default and take the consequences.” And the feds will say, “We have ways to make you want the bailout.”

    Isn’t that what happened to some of the financial firms in 2008? Hasn’t something like that happened with Greece? (I’m not sure, but I seem to remember reading about such things.)

    • #15
    • January 23, 2016, at 9:01 PM PST
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  16. The Reticulator Member

    Son of Spengler:Reticulator, you know the Golden Rule: Whoever has the gold makes the rules.

    I do think that it makes philosophical sense that any bankrupt or bailed-out state should be put into receivership. That is, if Feds pony up money, the state loses its sovereign status. Its legislature is disbanded and it gets a governor appointed by Congress. It loses its seats in Congress and its electoral votes. After 10 years, it can reapply for statehood.

    But I doubt that Congress would stick to principle. If PR gets a lifeline without any meaningful conditions, you can be sure that the same will be granted to any bankrupt state.

    Given that centralizers since Alex Hamilton have wanted to do away with the states as anything other than administrative districts, I’m afraid this would play right into their hands.

    • #16
    • January 23, 2016, at 9:10 PM PST
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  17. Son of Spengler Contributor
    Son of Spengler

    The Reticulator:I would foresee states saying, “No, we don’t need a bailout. We can handle this. We’ll just default and take the consequences.” And the feds will say, “We have ways to make you want the bailout.”

    Isn’t that what happened to some of the financial firms in 2008? Hasn’t something like that happened with Greece? (I’m not sure, but I seem to remember reading about such things.)

    That’s not at all what happened to Greece. Greece wanted the money without reforming. When the money was not forthcoming, Greece did in fact submit to certain terms. They wanted the money desperately; it was not forced upon them.

    You are correct, though, that that is what happened to banks in 2008. In that case, Treasury was concerned that identifying weak banks would accelerate the crisis, as people made a run on banks the government identified as weak. Do you see a similar mechanism regarding states? I find it hard to see how the federal government will have the resources to give enough money to bail out a 5-6 states AND force money on the other 45.

    • #17
    • January 24, 2016, at 1:02 PM PST
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  18. Son of Spengler Contributor
    Son of Spengler

    The Reticulator: Given that centralizers since Alex Hamilton have wanted to do away with the states as anything other than administrative districts, I’m afraid this would play right into their hands.

    That’s a tough contention to support. The history of what researchers term “cooperative” federalism, in which states become enforcers of federal power — as opposed to the Constitution’s “competitive” federalism, in which states and the central government have power over separate spheres — is considerably more rich and nuanced.

    The trend has certainly been in this direction. The book The Upside-Down Constitution by Michael Greve (of George Mason Law School and AEI) is a great (if dense) text on this history. It also explores why states find cooperative federalism attractive as well.

    Here is one of his recent essays on the topic — much shorter, and less theoretical than the book.

    • #18
    • January 24, 2016, at 1:16 PM PST
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  19. The Reticulator Member

    Son of Spengler:You are correct, though, that that is what happened to banks in 2008. In that case, Treasury was concerned that identifying weak banks would accelerate the crisis, as people made a run on banks the government identified as weak. Do you see a similar mechanism regarding states? I find it hard to see how the federal government will have the resources to give enough money to bail out a 5-6 states AND force money on the other 45.

    Yes, I see something like that happening with states, though it can’t happen all at once. That’s not how you make a frog sit still for boiling. Also, as you say, there isn’t enough money to make it happen all at once.

    • #19
    • January 24, 2016, at 5:22 PM PST
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  20. The Reticulator Member

    Son of Spengler: That’s not at all what happened to Greece. Greece wanted the money without reforming. When the money was not forthcoming, Greece did in fact submit to certain terms. They wanted the money desperately; it was not forced upon them.

    Yes, that’s a good part of the story. But part of it was also that Greece threatened to default. It would of course have preferred free money, but anybody who represents the creditors is going to want the debtor to take the bailout. The creditors can bring a lot of pressure to bear on the debtor to take the bailout, and the debtor can use that to leverage for better terms. But the creditor is also going to insist on some controls. I never heard of a bailout without strings attached.

    Don’t you think some of the resentment at Ford for not taking the same bailouts as GM and Chrysler is because Ford escaped some of the political control that GM and Chrysler were under?

    • #20
    • January 24, 2016, at 5:45 PM PST
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  21. The Reticulator Member

    Son of Spengler:

    The Reticulator: Given that centralizers since Alex Hamilton have wanted to do away with the states as anything other than administrative districts, I’m afraid this would play right into their hands.

    That’s a tough contention to support. The history of what researchers term “cooperative” federalism, in which states become enforcers of federal power — as opposed to the Constitution’s “competitive” federalism, in which states and the central government have power over separate spheres — is considerably more rich and nuanced.

    The trend has certainly been in this direction. The book The Upside-Down Constitution by Michael Greve (of George Mason Law School and AEI) is a great (if dense) text on this history. It also explores why states find cooperative federalism attractive as well.

    Here is one of his recent essays on the topic — much shorter, and less theoretical than the book.

    I have a hunch that the author wouldn’t agree with me that we need more of a crazy patchwork of state and local regulation and that its removal is as big a threat as ISIS.

    • #21
    • January 24, 2016, at 5:50 PM PST
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