Marc Joffe
With bankruptcy largely (but not totally) in the rearview mirror, Puerto Rico’s leaders are turning their focus once again to the island’s status. Many favor statehood, but that will require building support in Washington, DC. To increase the chance of Congress, the president, and states agreeing to admit Puerto Rico, the governor and legislature should consider a variety of pro‐market fiscal reforms.
Mainland‐based fiscal conservatives may be concerned about admitting a new state that does not have good credit. The last time one of the fifty states defaulted on a bond was ninety years ago. Indeed, there is no state bankruptcy process, and a lot of domestic opposition to creating one, so a future State of Puerto Rico should be fully out of bankruptcy court and able to avoid future bankruptcies on its own.
Puerto Rico required a bankruptcy process because it accumulated too much debt. By contrast, the fifty states have relatively little debt relative to their GDP. States generally do not borrow to cover operational costs, because 49 out of 50 of them have constitutional balanced budget requirements.
The 1952 Puerto Rico territorial constitution was also supposed to have a balanced budget requirement, but it was effectively voided due to a translation error. While the English version of the constitution limited Commonwealth expenditures to “total revenue,” this was translated as “recorsos totales” rather than “ingresos totales”. That led to a 1974 Attorney General opinion authorizing Puerto Rico to “balance” its operational budget with bond proceeds.
In the aftermath of the bankruptcy, Puerto Rico should amend its constitution to make clear that expenditures cannot exceed tax revenues, service charges, and grant funds. No other category of receipt should be considered when determining whether the Commonwealth’s budget is balanced.
The legislature could also consider other constitutional reforms to improve Puerto Rico’s fiscal sustainability. For example, South Carolina’s constitution requires a seven percent general fund reserve, while Colorado limits spending growth to the rate of population increase and price inflation combined.
Constitutional reform will increase the possibility of Puerto Rico being able to return to the municipal bond market, as potential investors see fiscal responsibility measures baked into the Commonwealth’s foundational document. Puerto Rico needs to become creditworthy because that is a requirement for winding down the Oversight Board and returning to normal governance.
Another financial practice watched by the bond market is the timeliness with which issuers produce their audited financial statements. On this score, Puerto Rico needs to improve. While most states produced their 2021 audits within 250 days of fiscal year‐end, Puerto Rico took 712 days.
The 2022 audit may appear in January, about 570 days after the fiscal year ended. This is an improvement but still worse than the vast majority of states, and longer than normally required by the federal government (nine months) and municipal bond market practice (six months). The Treasury Department should continue efforts to accelerate Commonwealth financial reporting while ensuring that auditors have the necessary information to render a clean opinion.
Further, Puerto Rico needs to fully conclude the current bankruptcy process by reaching an agreement with a larger group of PREPA (Puerto Rico Electric Power Authority) creditors. A recent plan of adjustment offered an average recovery of 25 cents on the dollar, with some creditors potentially receiving as little as 12.5 cents. While PROMESA (Puerto Rico Oversight, Management, and Economic Stability Act) supporters, like this author, recognized that lenders would have to take a haircut, the current plan amounts to a scalping.
Since institutional investors in the municipal bond market will be among those determining whether Puerto Rico is once again creditworthy and thus able to emerge from oversight, it is not in the Commonwealth’s long‐term interest to alienate them. Instead, the legislature should find more money to settle with PREPA (Puerto Rico Electric Power Authority) creditors by cutting other spending or using reserves.
Finally, the Commonwealth should actively monitor the credit of municipios and state‐owned enterprises. Defaults and bankruptcies among these entities will cast a pall on public credit across the island and should be avoided through early identification and intervention. North Carolina, Ohio, New York, and Michigan offer various models of local government oversight. The monitoring effort could be reduced by streamlining the Commonwealth’s public sector through consolidation of smaller municipios and privatizing more state‐owned enterprises.
Since passing PROMESA, the US federal government has provided extensive hurricane relief and pandemic‐related funding. It is now up to Puerto Rico to improve its financial practices to show that it can be a solvent member of the union, able to shoulder the responsibilities normally expected of US states.
This article originally appeared in Spanish in the Puerto Rico newspaper El Nuevo Día on December 29, 2023.
