SAN JUAN, Puerto Rico – Uncertainty is spreading across Puerto Rico and the U.S. municipal bond market now that the U.S. territory has taken an unprecedented step into federal court to restructure a portion of its $73 billion debt.
Many economists anticipated the island's move Wednesday to seek a bankruptcy-like process amid a 10-year recession, but no one can predict what lies ahead.
"Think about it as a marathon," said Craig Barbarosh, a bankruptcy lawyer with the firm Katten Muchin Rosenman. "Today is the beginning of mile 1. A lot can and will happen."
In the next couple of days, the chief justice of the U.S. Supreme Court is expected to appoint a federal district court judge to oversee Puerto Rico's case. The judge will ultimately decide how and which Puerto Rico assets will be distributed to bondholders. However, the judge will first need approval from the federal control board that was authorized by Congress last year to oversee the island's finances.
The decision to resolve a portion of the debt in court is the largest effort ever made by a U.S. government to shield itself from creditors. It's unknown how long the bankruptcy-like process will take, although local government officials believe it could be resolved in four years.
During that time, economists and analysts warn, many changes could occur.
"It's going to be uncomfortable for some," Barbarosh said. "It could mean everything from slightly higher taxes to ... modest adjustments to noncritical services ... to concessions by bondholders ... They're going to pull all the different levers."
Puerto Ricans already have been hit with new taxes, higher utility rates and cuts to public employee benefits, among other things. Many also have struggled to find jobs on an island of 3.4 million people with an unemployment rate that has hovered around 12 percent. Nearly 450,000 people have left for the U.S. mainland in the past decade to flee the crisis.
Islanders fear the situation could worsen under the court process, and federal control board chairman Jose Carrion noted that consensual negotiations with bondholders are preferable. He and Gov. Ricardo Rossello stressed that despite activating a process to restructure a portion of Puerto Rico's debt in court, they are still pursuing talks with creditors.
The talks broke down as a litigation freeze expired at midnight Monday, prompting creditors to file new lawsuits in an attempt to recuperate their multimillion-dollar investments in Puerto Rico bonds. Puerto Rico has defaulted on $1.3 billion in principal payments since August 2015, roughly a month after the previous governor declared that the island's public debt was unpayable and called for a restructuring.
Overall, Puerto Rico has $73 billion in public debt accumulated in part by previous administrations borrowing money to cover budget deficits. By comparison, the U.S. city of Detroit had less than $20 billion in debts when it filed for bankruptcy in 2013, which was the biggest U.S. municipal bankruptcy ever.
The control board said the move to restructure a portion of the debt in court will help Puerto Rico gain access to the capital markets after credit rating agencies downgraded the island's debt to junk status in recent years.
The U.S. territory's restructuring could ultimately set a precedent for the U.S. municipal bond market, although it's unclear whether it will regain immediate access, said Matt Freund, co-CIO and head of fixed income strategies at asset manager Calamos Investments.
"It always surprises me how quickly the market forgives and forgets," he said. "But this is a big enough event that it could be significant."
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