Puerto Rico Really Wants to Declare Bankruptcy — But It Can't

As Puerto Rico begins grappling with the steps that Gov. Alejandro García Padilla says are necessary for saving it from financial ruin, including cutting spending and stopping repayments on its huge debt as it is currently structured, the jury is still out on what measures the United States government will endorse to help the 3.5 million beleaguered American citizens who call the island home.

In a televised address on Monday evening, García Padilla said that both Puerto Ricans and the owners of its roughly $72 billion in public debt would have to "assume shared sacrifices today."

"It is time that those who lent to us also come to the table of sacrifices, at which we are already seated, so that later we can all together share the fruits of that sacrifice," he said, hoping that the creditors can be persuaded to alter the terms of the loans by lowering their interest rates or giving Puerto Rico more time to pay them back.

García Padilla's comments roiled the market for Puerto Rican bonds, as investors scrambled to gauge how much their holdings were worth.

Related: Why Are So Many Young Puerto Ricans Leaving Home?

Due to its status as a territory, Puerto Rico cannot file for Chapter 9 bankruptcy — an option that is afforded to American municipalities and which has been employed in recent years by cities like Detroit, Michigan, and Stockton, California.

While Puerto Rico doesn't have access to bankruptcy courts, its bonds fall under American jurisdiction, meaning creditors can easily sue Puerto Rico if and when it misses payments on its debt. Given its uniquely disadvantaged standing, García Padilla said that American legislators and the White House had to do more to help Puerto Ricans.

"It is time for us to ask for concerted actions from Washington," said the governor. "Action wherein changes can finally be made to Chapter 9, so that Puerto Rico can count on the same protections as other jurisdictions."

In February, Puerto Rico's non-voting member of the US House of Representatives, Pedro Pierluisi, proposed a bill that would allow the island's public corporations, including its electric, gas, and water authorities, to restructure their debts under Chapter 9. A similar bill would be introduced in the Senate by Sen. Richard Blumenthal (D-Conn.) and Sen. Charles Schumer (D-NY); a spokesperson for Blumenthal said that they hope to introduce the bill next week.

Puerto Rico's public corporations owe roughly $25 billion dollars to creditors. One of the first tests of García Padilla's new stance on debt was a $400 million payment due from its power authority, PREPRA, on Wednesday. It was reportedly delivered, but only after the authority obtained $128 million in short-term debt from insurance companies that have sold policies on its bonds and would pay investors in the event of a default. García Padilla's administration was also able to make a $645.2 million payment on its general obligation debt on Wednesday. Though both moves temporarily avoided a default, Puerto Rico's government — and PREPRA in particular, which owes some $9 billion to creditors — is not likely to meet future payments without restructuring.

While the White House on Monday said that there would be no bailout forthcoming for Puerto Rico, it encouraged Congress to take up Pierluisi's proposal of extending bankruptcy protection to the island's public companies. This stance was echoed by House Minority Leader Nancy Pelosi (D-Calif.), who said in a statement, "House Republicans should bring this legislation for a vote as soon as the House is back in session."

Gregory Serbe, president of Lebenthel Municipal Asset Management, told VICE News that in situations like Puerto Rico's, bankruptcy might be the fairest option — though he stopped short of endorsing it.

"Chapter 9 is very serious, but it's the only way you can force everybody to sit down and have the courts help solve what's a very confusing situation," said Sherbe. "The bondholders may come out on top, they may come out on the bottom, but it's probably the neatest way of doing it. It's also the most complete way."

In lieu of bankruptcy, Sherbe said that the most likely solution would involve "a change in interest rates [of its bonds], a change in the maturity, and a reduction in the amount they owe." These would be dismaying conditions for investors who bought general obligation bonds, which are constitutionally guaranteed to be paid before Puerto Rico's civil servants, pensioners, and welfare recipients. On Monday, García Padilla insisted that those bonds must be included in restructuring plans. Any such steps would likely face significant opposition from creditors.

Related: In Photos: Massive Protests in Puerto Rico Over Plan to Slash Spending on Higher Education

Puerto Ricans have felt the pains of austerity for years, as their government has attempted to freeze a debt load that dwarfs, per capita, that of any US state. Its total debt amounts to half that of California, which has 11 times Puerto Rico's population.

Though the roots of Puerto Rico's economic decline are deep, a report commissioned by García Padilla's government and drafted by a team of former IMF officials cited the 2006 expiration of several important tax breaks for corporations as a cause for the depletion of the island's manufacturing sector. It also noted high energy and labor costs, a weak housing market, and population loss as factors in the decline.

Despite warning signs, Puerto Rico's bonds were for many years rated highly by agencies — its debt was lowered to below investment grade only in 2014. The bonds attracted lots of buyers because they are tax-exempt; the island's total debt tripled since 2000. The report found that Puerto Rico's government was consistently "overly optimistic" about revenue projections and budgets. Its Office of Budget Management has "no enforcement power to oversee cuts" in spending, the report noted, while its Department of Treasury made a habit of offering tax amnesties or negotiated discounts to tax evaders.

The layoffs, higher taxes, and pension cuts of the past several years have only helped to escalate a historic exodus from the island. Over the past decade, due to negative net-migration, Puerto Rico's population has decreased by at least five percent. On Wednesday, Puerto Ricans awoke to yet another tax increase, this time a rise in the island's sales tax from 7 to 11.5 percent.

Republican members of Congress, backed by well-funded conservative groups, have pushed against granting Puerto Rico access to bankruptcy court. One of the leading voices against such a move is a group called the 60 Plus Association, which bills itself both as a "non-partisan seniors advocacy center" and "the nation's largest center-right senior advocacy organization." 60 Plus' national spokesperson is conservative pop crooner Pat Boone, and its chairman is longtime Republican operative James Martin. On Tuesday, hours after García Padilla's remarks, Martin released a statement that heavily criticized the White House' suggestion that Congress consider Chapter 9 for Puerto Rico.

"Let's be clear," he said, "Chapter 9 bankruptcy protection is a bailout."

Between July 2008 and June 2013, five groups connected to billionaire brothers Charles and David Koch financed the group to the tune of nearly $42 million dollars, according to the Center for Public Integrity.

On a website called nobailout4pr.com, 60 Plus recently endorsed the proposal of Rep. Jeff Duncan (R-SC) to institute a federal financial control board for Puerto Rico. Financial control boards have been used previously in the US, notably during the mid-1970s, when New York State created one to manage a fiscal crisis in New York City.

Observers say a better comparison is the board that essentially ran Washington, DC's government from 1995 to 2001. That body, like the one Duncan and others have proposed, was federally controlled. Many in Puerto Rico, where the independence movement continues quietly, see the proposal as tantamount to colonialism. But were Washington to assume responsibility for handling the crisis in Puerto Rico, it would also take some pressure off of local politicians who have been loath to make painful cuts.

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Richard Ravitch, a former New York lieutenant governor, said Duncan's proposal would give the board more than authority than New York's 40 years ago, for which he served as an advisor, or Detroit's current board, which was formed after the city filed for bankruptcy and which he also advises.

"In New York and Detroit it was there to make sure that elected officials comply with the plan that was approved," Ravitch told VICE News. The board proposed by Duncan and others, he said, "would be the de-facto government — it would preempt local officials."

Opponents of measures to assist Puerto Rico frequently point to what they call endemic corruption on the island. When VICE News visited Puerto Rico earlier this year, many residents pilloried their political class, which for years has divvied up funds among well-connected consultants and political operatives. Others bemoaned a lack of concern on the part of Washington.

Puerto Rican bonds are widely held by mutual funds, individuals, and, increasingly in recent years, by hedge funds. It is the latter group that probably concerns García Padilla's administration the most, given their willingness to engage in drawn out litigation with debtors. Hedge funds stand to make large profits should they be repaid at 100 cents on the dollar, and would likely support the proposal for a financial control board.

Ravitch, who has consulted with García Padilla's administration and other Puerto Rican entities pro-bono, said that bankruptcy was the best possible outcome for Puerto Rico.

"We have to fix the situation somehow, so we need bankruptcy to help the people of Puerto Rico," he said.

Ravitch recalled President Gerald Ford Ford's 1975 televised address, when he said Washington would not be bailing out New York. The position led to the famous Daily News headline: "FORD TO CITY: DROP DEAD."

Two months later, Ravitch noted, he was in the Oval Office as Ford extended more than $2 billion in loans to the city. But he said part of the problem for Puerto Rico, unlike New York, is how little attention is paid to it, despite the plight of its residents.

"Who knows what they'll do if there are real serious social and human problems?" he wondered. "The potential consequences are very sad."

Follow Samuel Oakford on Twitter: @samueloakford