Earlier this week, Puerto Rico, an American territory, sought “bankruptcy” protection after years of economic downfalls and facing $123 billion in bond and pension debts. So why did it take over two years for the island to address these problems?

First off, it’s not exactly bankruptcy since Puerto Rico is only a territory and the island cannot receive the same Chapter 9 protections like the states. Second, it was not until last year that Congress passed the Puerto Rico Debt Relief Bill:

The legislation would create a federal oversight board, appointed by Washington, with power to restructure Puerto Rico’s unmanageable debt load.

The bill provides for a stay, or halt, to any litigation brought against the Puerto Rican government and its debt issuing agencies that is retroactive to December. This provides breathing room for the board to start the process of restructuring and oversee a sustainable budget process.

The Puerto Rico Financial Oversight and Management Board

This committee invoked that law passed by D.C. in June of last year. This means that the island’s “standoff with creditors” will now go “before a federal judge in San Juan in a restructuring process known as Title III.” Supreme Court Justice John Roberts will select a judge to hear the case. He may choose any federal judge he wishes.

The Wall Street Journal explained how this will work out:

Chapter 9, which the city of Detroit used to obtain $7 billion in debt relief, relies on elected officials to negotiate with creditors and design repayment schemes. Under Title III, the federal board overseeing Puerto Rico’s finances is responsible for restructuring negotiations. The board, comprised of appointed technocrats, was designed to take local politics out of the equation. “Unlike chapter 9, a Title III case is not led by elected officials,” said Susheel Kirpalani, a lawyer for sales-tax bondholders. “That is a critical point to depoliticize the government’s restructuring and hopefully will lead to fairer outcomes for creditors.”

Settlement talks haven’t produced an agreement so far, but the board said it still wants to strike deals. If it can’t find takers, however, it can ask a judge to approve a plan over the objections of creditors, as in chapter 9. The board is required to “respect” creditor liens and priorities, but no one knows if that gives creditors real ammunition to resist forcible write-downs.

The court filing listed these problems. From NPR:

Puerto Rico’s labor participation rate is only about two-thirds that of the U.S. mainland.

The territory’s population has dropped by 10 percent since 2007.

Nearly half of Puerto Rico’s residents live below the federal poverty level.

How Did Puerto Rico Get In This Mess?

This did not happen overnight. In fact, it started decades ago. As of right now, Puerto Rico has “$74 billion in bond debt and $49 billion in unfunded pension obligations.”

The island has struggled to create jobs since Congress ended the federal tax credits it enjoyed. The local leaders tried to “cut spending and boost tax collections,” but they decided to take the borrowing route:

For over a decade, Puerto Rico’s government and its municipal corporations borrowed more to buy time to stave off deeper economic overhauls. With government payrolls down over the past decade, pension funds have fewer workers contributing and the plans are now underfunded by an estimated $45 billion.

The investors decided to ignore the financial problems:

For years, investors overlooked these fiscal and demographic problems because Puerto Rico’s bonds offered high yields and because they believed the island’s economy would eventually recover. Puerto Rico can issue debt exempt from federal, state and local taxes, unlike U.S. states, which made these bonds attractive to many mutual-fund investors and more recently, hedge funds.

But Puerto Rico began to lose access to the credit markets three years ago, when its ratings were downgraded. The door closed for good in 2015 when the island’s governor declared the debts unpayable.


Reality? The investors will probably not receive as much money as they want. USA Today points out that if the investors “hold secured bonds, they might get paid in full.” Without secured bonds, they “could suffer significant cuts, depending on which types of debt the judge determines to be vulnerable.” The main fight comes from two bondholders: Confina bonds and GO bondholders. From NASDAQ:

The Cofina camp argues that its claims on tax revenue are protected by the bond indentures and should not be used to pay holders of the island’s general obligation bonds.

The GO bondholders meanwhile have seen Puerto Rico default on their payments while staying current on the Cofina debt, because the taxes have already been remitted to the trustee.

Before Puerto Rico declared bankruptcy, these bondholders tried to work out “a deal with the government that would have valued their debt at 70 cents on the dollar.” But now the bonds have started to trade “around 66 cents on the dollar.”

Honestly, no one knows for sure what will happen next because this has never happened before. But these bondholders believe their should receive money first.


The creditors believe they deserve money first, but what about those who have retired and need to receive pensions? The law Congress passed last year demanded that Puerto Rico “provide adequate funding for public pension systems.”

When Detroit sought protection, the retirees accepted “cuts after a judge ruled that their pensions could be cut in municipal bankruptcy.” Yet, under bankruptcy, the protections given to pensioners could collapse.

However, as Municipal Market Analytics analyst Matt Fabian said, the pensioners could “still fare better than investors” since they “are more politically empathetic than Wall Street creditors and bond insurers.”


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