America’s sunniest place, Puerto Rico, faces dark days, and the likelihood is rising that Washington will be asked to step in. While the rest of the United States recovers economically, the commonwealth’s economy remains stuck in a decade-long recession. Puerto Rico’s unemployment rate is double that of the mainland U.S., despite one of world’s lowest labor participation rates. And with such prospects, nearly 10,000 Puerto Ricans every month leave the commonwealth for the mainland.
It’s actually even worse. For years, fixed business investment in Puerto Rico has grown at half the average rate of the 13 Caribbean nations, and recently foreign investors have been cashing out their Puerto Rican financial assets and closing their Puerto Rican operations. And the commonwealth’s public debt is rising at such an unsustainable rate that Moody’s and Standard & Poor’s have downgraded it to junk status.
The first rule for such dire times is that the government should do whatever it can to rebuild confidence and draw in new investment. Yet, Gov. Alejandro Garcia Padilla seems intent on steering in a different direction. First, he rattled bondholders by forcing through new legislation of doubtful constitutionality that allowed Prepa, the island utility, to restructure its debt. And after losing a court case to one of the island’s major banks, the governor is threatening to defy the judgment.
The case involves Doral Financial Corporation, which years ago overstated its earnings and consequently its taxes. After years of negotiations, the Commonwealth Treasury had agreed to provide Doral with $230 million in tax refunds over five years, until Padilla’s treasurer unilaterally the agreement. And when Doral won the case in court a few weeks ago, the governor decried the result as “immoral” and said it would be against the public good to abide by the decision.
Not only did the commonwealth’s government unilaterally renounce its contractual obligations to Doral and now threaten to defy the courts; officials also have warned Doral’s executives that unpleasant investigations will follow, and a whispering campaign against the bank and its top management is in full swing. And if Puerto Rico’s rejection of the court’s ruling persists, the consequences for Doral, a major island employer and mortgage lender, will be dire. The Federal Deposit Insurance Corp. has said unless Doral can book the $230 million refund, it will find itself with inadequate reserves and possibly forced to close.
In the next few weeks, Padilla will ask Wall Street to float almost $2.5 billion in new bonds. Even before the Doral case was decided, Moody’s had ranked Puerto Rico as the second most likely place in the world to default on its debts — right after Argentina, which has since defaulted on its debts. In addition, the Government Development Bank is also said to be virtually broke. Now, the governor must ask himself why anyone would lend Puerto Rico that kind of money when its government renounces its contracts and questions the rule of law.
The new offering could fail, or it could “succeed” with a very high coupon rate. In either case, Washington intervention appears to be rising. Indeed, Padilla may already have a federal bailout in mind. True, it’s difficult to imagine Congress or the White House going along. But if a disastrous default is the other alternative, and a bailout of some kind happens, it will cost Puerto Rico dearly. Congress has the authority to take control of the island’s fiscal affairs — and that will be the price for any federal guarantee or bailout. Like the financial controls used to address the District of Columbia’s fiscal crisis in the late 1990s, Padilla would find Congress managing Puerto Rico’s payments to creditors, pension obligations and overall budget.
The commonwealth has time to avoid this drastic scenario, if the governor is prepared to reverse course and do what it takes. He could start by signaling to American, Puerto Rican and foreign investors alike that Puerto Rico’s government keeps its word and respects the law. He could accomplish much of that by honoring his Treasury’s agreement with Doral and respecting the court’s recent judgment in that case. Once that is behind them, Padilla and his advisers should consider Ireland’s model of economic development. The goal is to make Puerto Rico the preferred jumping-off point for foreign multinationals to enter the U.S. market. The basic method is simplify taxes, reform regulations and expand public investments in ways that attract large foreign direct investments from Latin America, Asia and Europe.
The first step, however, is to govern responsibly.
Robert Shapiro, chairman of the Washington advisory firm Sonecon and former under secretary of commerce (1997-2001), has been an adviser to Doral. Simon Rosenberg is the founder and president of NDN, a Washington think tank.