AEI panelists ponder what’s next for P.R.’s economy
Daniel Hanson of Height Securities LLC speaks Feb. 11 at an AEI seminar in Washington DC on Puerto Rico’s debt crisis. Next to him is attorney Thomas Moers Mayer of Kramer Levin. (Credit: Larry Luxner)
WASHINGTON — Puerto Rico’s fiscal crisis is the direct result of poor governance and mismanagement, and an inefficient welfare system and over-regulation is only making things worse, argued a five-member expert panel meeting in Washington.
The American Enterprise Institute, a conservative think tank, hosted the Feb. 11 event, “How to Address Puerto Rico’s Fiscal Crisis,” as Congress holds a series of hearings on the island’s $70 billion deficit.
Economist Anne Krueger of the Paul H. Nitze School of Advanced International Studies said Puerto Rico has traditionally overestimated growth while underestimating how much the economy would shrink as a result of losing Section 936 tax breaks.
“In the late 1970s, Congress, in its wisdom, exempted companies that moved their factories to Puerto Rico from U.S. corporate taxes, but the companies that took advantage of this were largely pharmaceuticals. The inversion we now hear about was nothing compared to the tax breaks companies were given for moving there,” she said, noting that those tax breaks were phased out over a 10-year period ending in 2006.
“Unless they can somehow restore growth, it doesn’t matter what you do,” said Krueger. “They’ve got to make investments in the Electric Power Authority, although they can’t right now because it’s going bankrupt. In addition, all but a little of their power is based on oil, and oil is even more expensive in Puerto Rico because of the Jones Act.”
Furthermore, the federal minimum wage — which applies in Puerto Rico — is a real deterrent to investment, and “raising taxes will just encourage more out-migration” to the U.S. mainland.
“When you have lots of different entities within the government and no orderly procedure for sorting it out, the lawyers will have fun and keep the mess going for several years,” she warned. “The downslide will continue and get worse.”
One of those attorneys, Thomas Moers Mayer of the New York law firm Kramer Levin, placed much of the blame squarely on the Government Development Bank (GDB), whose $420 million payment is due May 1.
“That’s the real crisis if there is one,” he remarked. “The GDB holds $4 billion of deposits. The FDIC does not insure those and that’s how the island makes its payroll. Come May, the island may not make payroll. What is anyone doing about that?”
Mayer called Chapter 9 bankruptcy protection a “debt restructuring mechanism that will impede Puerto Rico’s access to the capital markets,” noting that his clients invested about $10 billion in Puerto Rico bonds on behalf of more than 600,000 individual retail investors.
“The typical municipal bond investor is over 65 and reports income under $100,000,” he said. “All of these investors bought these bonds after 1984, when Congress excluded Puerto Rico from using Chapter 9. It’s these investors who finance not only Puerto Rico’s operating deficit, but its bridges and highways and water. Puerto Rico needed their investments in the past, and will need their investments in the future.”
Brad Setser, an expert with the Council on Foreign Relations, said that although the island needs Chapter 9, such protection won’t be nearly enough to help the island.
“Puerto Rico suffers from unquestioned weakness in its fiscal institutions,” he said. “The core source of its difficulties has been the systematic overestimation of revenue — which leads to persistent budget shortfalls, covered when possible through borrowing, and when not possible, by not making payments on debt owed to the GDB and payments to the pension system.”
In addition, Setser argued, “Puerto Rico has an unusually large, complex debt structure, particularly for entities which are supported by the commonwealth taxing authority There needs to be a form of external oversight that strengthens from the outside and helps Puerto Rico rebuild its own fiscal institutions.”
Among other things, said the CFR expert, any proposed oversight board:
- Needs to provide an independent estimate of Puerto Rico’s revenues that feeds into the budget process, and the amount of revenue that would be raised through any new measure the government contemplates.
- Must spell out an agreed long-term fiscal baseline that would “function much the same way an IMF program functions for an emerging economy” and put the annual budgeting cycle in the context of a multi-year plan.
- Must approve the annual budget, and the board should have the authority — if expenditures exceed projections, or if revenues fall short — to make across-the-board sequester-style cuts.
Daniel Hanson of Height Securities LLC suggested that “reducing the scope of the government sector is one of the many ways we can spur growth” on the island.
“A shrinking population has left certain sectors much too large,” Hanson complained. “For example, Puerto Rico has more teachers than it did four years ago, despite the fact that enrollment is down by 26 percent.”
Desmond Lachman, a senior fellow at AEI, compared Puerto Rico’s fiscal crisis to that of Greece, suggesting that in addition to a financial control board, there must be economic growth.
Both Greece and Puerto Rico are in monetary unions, and both have seen GDP fall dramatically in recent years.
“In 2010, Greece should have restructured its debt by 30 percent and put itself on a path of sustainability. Instead, they delayed that restructuring and tried to contain the budget. The result was that in 2012, they had to write down the debt by 75 percent, and austerity will lead them to have another writedown sometime later this year,” he said.
Unlike Greece, Puerto Rico — a territory — “doesn’t have membership in the IMF to help them get bailed out. But it does have Congress,” Lachman said, adding that “labor mobility [to the U.S. mainland] keeps Puerto Rico from having Greek unemployment levels.”
Yet without serious economic growth,” he warned, “I’m afraid Puerto Rico will just go from one debt restructuring to another.”
