Ability vs. willingness to pay in Puerto Rico
Financial markets have drawn a sharp distinction between the concepts of unwillingness to pay and inability to pay. It is the difference between someone who charges too much on his credit card but has a steady income from a stable job and someone who experienced a 40 percent salary cut. The unwillingness to pay could be solved with budget cuts, higher taxes and a fiscal control board that can impose politically unpopular measures. The inability to pay is a reflection of an eroded economic base and no reasonable austerity effort can generate the necessary resources to pay the debt.
{mosads}An example of unwillingness to pay was Washington, D.C., in the 1990s. The District was living beyond its means, but such means were still significant. The federal government was still there, generating tens of thousands of direct jobs and corresponding indirect jobs. Tourists continued to flock to the city. Countless institutions populated D.C., from world-renowned Georgetown University to policy think-tanks. While there were some significant issues in the relationship of the District to the federal government that needed to be addressed, the economic base of Washington was still doing relatively well.
At the time, a federal financial-control board could impose responsible budgets in the District. Austerity measures in terms of reducing city budget had a minor impact on the economy of the District; the federal government was the key player and continued humming along. Even then, the federal government supported Washington by taking all its pension deficit liabilities and covering the cost of some government functions previously paid by the District, such as the imprisonment costs of D.C.’s felons.
Detroit faced a different challenge. It was not only living beyond its means, but such means also had declined sharply as a result of the decline in the auto industry. By the time Kevyn Orr was named emergency manager by the governor of Michigan, no amount of cost-cutting and austerity could avoid a debt restructuring. As in Washington, people were leaving the city, thus reducing the tax base. Unlike in Washington, there was no strong economic base still standing to entice people to return.
Puerto Rico is closer to Detroit. It certainly has a more diversified economy, but its key manufacturing sector, pharmaceuticals, has been in decline. It is losing population at a rate of almost 2 percent per year, not far from Detroit at its worse. And Puerto Rico has a major drawback compared to Washington and Detroit. Its population doesn’t move to the suburbs, but across the ocean.
The unfunded pension liability of Washington at the time of the Revitalization Act of 1997 was approximately $5 billion, similar to the District’s budget at the time. In contrast, at the time of bankruptcy, the unfunded pension liability of Detroit, $3.5 billion, was about three-and-a-half times its budget. Meanwhile, Puerto Rico’s unfunded pension liability stands at somewhat over $40 billion, about four-and-a-half times the territory’s budget.
Nuveen Asset Management, a major manager of municipal-bonds mutual funds, reluctantly accepted that the situation in Puerto Rico is a problem of inability to pay rather than unwillingness to pay. As it stated in a report dated February 2016:
We believe the final [congressional] legislation must include a path for Puerto Rico to restructure these liabilities. We don’t advocate for restructuring authority lightly. As investors, we prefer political solutions that avert restructuring whenever possible. Yet we believe when an issuer reaches the point where debt reduction becomes inevitable, any delay only serves to engage in value destruction through additional unsustainable borrowings, economic contraction and/or population loss due to reduced government services. Thus the restructuring — painful as it may be — provides greater value to creditors than lobbying for maintaining the status quo.
Amen.
Feliciano is president of Advantage Business Consulting, which provides consulting services to the government of Puerto Rico on economic and tax policies, but not debt policy.