August 1st is a day that may make the history books in Puerto Rico. This Saturday (technically Monday, since the deadline is on a weekend) Puerto Rico has a major debt payment due in the amount of $58 million that it’s not going to pay. For the first time in its history, Puerto Rico will default.
Puerto Rico has been threatening default since the beginning of time, which has led most creditors to believe its administrators are, yet again, crying wolf. This time will likely be different. Throughout the week, the Governor of Puerto Rico, through his Chief of Staff, has continuously confirmed that Puerto Rico will be unable to make the full payment required by COB Monday. Sources have told me that Puerto Rico has transferred finances to its debt paying authority in an amount that is short its total bill. After years of threats, it’s finally going to happen.
After years of threats, it’s finally going to happen.
- Justin Vélez-Hagan
My final confirmation comes from the fact that the island’s top leaders have all left Puerto Rico. Governor Garcia-Padilla is attending a conference of Governors in Colorado, and will be on vacation when Doomsday rolls around. The Secretary of State (second in command) has also left, while President of the Senate and the Speaker of its House of Representatives have all hightailed it out of town, leaving but the little known Secretary of Justice in charge of the government. “Default and flee?” as one analyst quipped on Twitter.
A number of analysts contend that Puerto Rico technically has the funds available to make a payment, but is choosing to strategically default on this particular payment for a number of reasons. Financial docs have shown that Puerto Rico should have enough cash to get through September. But, if default is inevitable, it’s probably wise to invoke some sort of strategic plan to manage which loans are defaulted on, when, and how.
The particular Public Finance Corporation (PFC) bond payment that is due August 1st is the one that is backed by the weakest guarantee in Puerto Rico. Many bonds are backed by the “full faith and credit” of the island’s government, or are supported by the financial streams of a specific tax including the other two bond payments that are due August 1st (both of which are expected to be paid). However, PFC bonds are only paid if the legislature appropriates the necessary funds. Legislators in Puerto Rico (intentionally) failed to do so recently, and other administrators have decided to just wait and see what happens.
Puerto Rico on verge of crisis after governor says island can't pay its public debt
Already hurting over economy, Puerto Rico now faces severe drought, water rationing
Gov. O'Malley to be first 2016 presidential candidate to campaign in Puerto Rico
Jeb Bush tells Puerto Rican leaders he supports statehood, pledges compassion
After 63 years Puerto Rico as a commonwealth is ready for retirement, many say
While Puerto Rico sinks in debt, residents flee in record numbers to the U.S.
The wake, Puerto Rican style
Borinqueneers: Puerto Rico's Forgotten Heroes
Puerto Ricans flee island on brink of financial collapse
Why would Puerto Rico want to default now if it doesn’t have to? If administrators realize that a default is imminent, it also knows that it will have to negotiate a restructuring plan at some point as well. The two parties to this negotiation are major debt holders (large financial institutions and hedge funds who were the last remaining investors willing to take on the high risk of Puerto Rico’s latest bond issues) and the government. Bondholders have pushed Puerto Rico to implement more drastic spending cuts in order to make payments, even issuing a recent report by former IMF officials detailing how it can be done. Puerto Rico has refused to do so and, until now, has only threatened to miss payments. A stalled negotiation process means someone has to make a big move. Missing this debt payment is Puerto Rico’s shot across the bow.
Missing a payment doesn’t just mean that Puerto Rico’s threats will be taken seriously. It also gives the island an advantage in any potential restructuring negotiations, and adds a little pressure on Washington to get in on the action. As bond values fall, as they have and are expected to continue doing so once a default occurs, owners of that debt are going to want to stop the bleeding by coming to the table. Puerto Rico will also be able to negotiate a higher percentage haircut on the returns to investors, if prices are lower. A stubborn Congress has confirmed time and again that it isn’t going to get involved by allowing Puerto Rico to avail itself of bankruptcy protection, while an equally obstinate White House isn’t interested in doing anything that the public might consider a “bailout.” Hedge funds (and other large debt holders) have simply had no incentive to help Puerto Rico, as doing so would run contrary to the purpose of their firms.
In the minds of Puerto Rican leaders, even a relatively small default just might be move that finally gets some help from Washington, or brings investment firms to the negotiation table.
Will Puerto Rico’s economy simply cease to operate come Monday? Not even close, in fact, I’ve been secretly hoping that Puerto Rico would default sooner than later so it can finally begin getting past this debt fiasco. It’s been inevitable for years, and putting it off has only added an additional and unnecessary burden to its decade-long shrinking economy. Unfortunately, default is the best thing that can happen to Puerto Rico.
Justin Vélez-Hagan is the founder of The National Puerto Rican Chamber of Commerce and an economic policy researcher at the University of Maryland. He is also the author of The Common Sense behind Basic Economics. He can be reached at JustinV@NPRChamber.org or @JVelezHagan.