Everything You Wanted to Know About the Puerto Rican Debt Crisis But Were Afraid to Google

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Puerto Rico Teeters On Edge Of Massive Default
Paradise lost. Photo: Joe Raedle/2015 Getty Images

Puerto Rico just defaulted on a $422 million debt payment. That’s the largest default yet in a debt crisis that already has schoolchildren suffering, bondholders sweating, Paul Ryan beating back a mutiny, Democrats feeling good about their chances in Florida this November, and you searching the internet for an explainer on this whole mess.

Here, then, is everything you need to know about the Puerto Rican debt crisis:

How did Puerto Rico get into this fiasco?

The short answer is that the island has been in recession for ten years and, during that decadelong downturn, its government papered over budget shortfalls by borrowing gobs of money from foreign investors.

What’s the long answer?

Laws passed by the U.S. Congress inflated a massive manufacturing bubble in Puerto Rico, then popped it, while simultaneously encouraging investors to buy the island’s debt, even when the territory’s economy was in distress.

For over 80 years, the federal government used tax breaks to coax corporations into operating in Puerto Rico, so as to boost the island’s industrialization and keep tax-allergic companies on American soil. The most significant of these was “section 936” — a provision of the tax code which gave U.S. companies an exemption on all income originating from American territories. After the provision was passed in 1976, manufacturers and pharmaceutical companies flooded the island with jobs. Manufacturing became the single most important sector in Puerto Rico’s economy.

But the island’s competitiveness rested on those tax breaks — Puerto Rico has the same minimum wage as the United States and its workers are less productive. In the ‘90s, anger over outsourcing and corporate tax evasion led Congress to phase out section 936. (If Puerto Rico were a state, with two senators and a congressional delegation, it’s possible the island would have retained some version of the benefits.)

By 2006, the exemptions were history and so was Puerto Rico’s manufacturing boom. The territory has been in recession ever since. But the island did see continued growth in one of its prime exports: debt. Mutual funds were still eager to buy Puerto Rican bonds, even as its economy languished, because those bonds are “triple tax exempt,” which means their interest payments go untaxed by federal, state, and local governments.

So why don’t they just declare bankruptcy, like Detroit did?

Unlike U.S. municipalities, Puerto Rico isn’t covered by chapter nine of the U.S. bankruptcy code.

Gotcha. So, that’s why we’re bailing Puerto Rico out: Our laws are partially responsible for their plight.

Yes and no. The federal government is partially responsible for the island’s financial distress but no one is asking U.S. taxpayers to bail Puerto Rico out.

But I saw a bunch of ads 

A dark-money group called the Center for Individual Freedom has spent hundreds of thousands of dollars on television ads that paint the House’s current plan for restructuring Puerto Rican debt as a bailout. But the bill that Paul Ryan is desperately trying to rally his caucus around will cost U.S. taxpayers absolutely nothing. Instead, the legislation would empower a federal oversight board to oversee debt-restructuring agreements and approve or reject local budgets on the island.

Basically: You can’t collect money from an island of broke, starving people. So, it’s in the interest of the creditors themselves to get Puerto Rico’s debt load down to a point where it can still fund the basic services necessary for economic growth. But some creditors with low-priority debt are likely to lose out on any restructuring agreement. And others would like Puerto Rico to hand over its retirees’ pensions and then collapse into a failed state if it has to. Under the current bill, the oversight board could force creditors to accept a restructuring agreement if two-thirds of their peers say yes or with judicial affirmation. So a lot of money is being channeled into fearmongering ads and strong-arming lobbyists. And a lot of Republicans are reluctant to sign onto Ryan’s bill.

But there are Democrats in Congress, too. Couldn’t Ryan pass it with their votes?

Yes, but that’s just the sort of maneuver that forced John Boehner into early retirement. Ryan wants to pass this thing with a majority of his own caucus.

What happens if they don’t pass anything?

This July, Puerto Rico will stare down a $1.9 billion bill, much of which is composed of payments on general obligation bonds. Unlike the bonds Puerto Rico failed to pay on Monday, general obligation bonds are constitutionally protected — if the island defaults on those, it would be forced into legal purgatory. With no bankruptcy process in place, Puerto Rico and its creditors would battle out their disagreements in court, possibly for years. That legal limbo would scare off new investment, plunging the territory into a deeper recession. As it is, the Puerto Rican government can’t finance basic services, like fuel for school buses and police cars.

Wait: Puerto Ricans are U.S. citizens. If things get really bad there, wouldn’t they all just move to Florida or something?

Yes. The island lost nearly two percent of its population in 2014 alone, as 84,000 Puerto Ricans emigrated to the mainland. The highly educated are fleeing in disproportionate numbers; according to Puerto Rico’s Institute of Statistics, the island lost 17,000 residents with a post-secondary degree in 2014.

Lets say I view all news through the narrow prism of partisan politics: Could the suffering of the Puerto Rican people potentially benefit Democrats this November?

Yes. Politico’s Marc Caputo lays out the case here.

Puerto Rico’s Debt Crisis: What You Need to Know