THE BURNED OVER DISTRICT

As the financial problems of America's last sizable colony continue to mount, one of the proposed solutions comes straight out of the "Trash the Government" playbook, slash education funding.

On Aug. 1, Puerto Rico defaulted on a bond payment, setting the stage for a protracted fiscal battle between the U.S. territory and its creditors. San Juan paid only $628,000 toward the $58 million on its Public Finance Corp. bonds, though it managed to pay nearly $500 million in other debt payments due on Aug. 3. The selective default may be a gambit because Puerto Rican residents, who are owed much of the overdue payment via credit unions, are unlikely to pursue the legal remedies that litigious hedge funds would be expected to aggressively undertake.

The island’s economy is buckling under a staggering $72 billion debt. In June, Gov. Alejandro Garcia Padilla urged investors to renegotiate the terms of repayment, calling the debt “unpayable.” But hedge fund investors, who bought up Puerto Rico’s distressed debt, are demanding austerity measures that would exact a toll on the public. And they have rejected proposals to restructure the debt, which would reduce their returns on investment but enable the economy to recover.

Proponents of severe austerity measures attribute Puerto Rico’s debt crisis to fiscal mismanagement and corruption. They are calling for punitive reforms that suggest the island is solely responsible for its dire predicament. While Puerto Rican authorities have no doubt contributed to the island’s economic distress, investors contributed to the troubles by wagering on risky investments. The island was attractive in the municipal bond market until the crisis hit because of high yields and exemptions from federal, state and local taxes. In addition, its colonial history and globalization played prominent roles in creating and sustaining the structural deficits that made the commonwealth a target for the ruthless investors that are now demanding their pound of flesh.

And that colonial legacy extends into the present. Puerto Rico does not enjoy many of the benefits afforded to U.S. states, including the right of its municipalities to file for bankruptcy. The 1st Circuit Court of Appeals on July 8 affirmed a federal district court’s decision in February that found that Puerto Rico’s 2014 debt restructuring law was unconstitutional. In addition, the island lacks voting representation in Congress, which continues to dictate its fate. And because of its status as a U.S. territory, Puerto Rico is ineligible for multilateral loans made to sovereign countries...
What’s more, the island’s health care system is collapsing. Nearly 60 percent of the commonwealth’s residents rely on Medicare and Medicaid, but the lower rate of reimbursement has prompted an exodus of doctors. The federal government is expected to impose an 11 percent cut in Medicare Advantage plans in January, and Medicaid funding may also be curtailed.

Despite these dire circumstances, investors are calling on San Juan to slash public spending. A new report, “For Puerto Rico, There Is a Better Way,” commissioned by a group of 34 hedge funds that hold an estimated $5.2 billion of Puerto Rican bonds, recommended a typical austerity package: tax increases, harsh spending cuts — including teacher layoffs, school closures and health benefit reductions — The report criticized Puerto Rico for excessive outlays on education. (The island spends $8,400 per student, far below the U.S. average of $10,667.) More than half of Puerto Rico’s children live in poverty, and the government has already closed nearly 100 schools this year, in addition to 60 closures last year. These arguments are self-serving and greedy: The hedge funds are asking the Puerto Rican people, especially its children, to make deep sacrifices, but they are unwilling to accept any themselves. privatizing public resources.

Just as in Europe with Greece, we see lenders making risky loans and demanding that the borrower shoulder the burden of their risk so as not to jeopardize their 100% return. Risk is for the little people. What the hedge funds needs is a deep, deep haircut, but that is not likely to happen.