Is Puerto Rico the Next Detroit?

I have been waiting for Illinois to be the first state to be forced into bankruptcy, and it may still win that race. But, while watching cities race toward bankruptcy, I had forgotten that there are other entities that are larger than counties but not the same as states—U.S. Territories.

From the New York Times Dealbook blog:

Puerto Rico’s fiscal agent has hired another well-known restructuring law firm, raising the specter that the financially troubled island is preparing to revamp its finances.

The Government Development Bank for Puerto Rico, which oversees all of the commonwealth’s debt deals, said it had hired Cleary Gottlieb Steen & Hamilton.

The development bank declined to say whether Cleary had been hired as part of an effort to restructure the commonwealth’s debt.

“The G.D.B. regularly solicits advice and counsel from a number of legal and financial advisers with respect to financing plans and other related matters,” a spokesman for the development bank said in a statement. “Cleary Gottlieb Steen & Hamilton were engaged by the G.D.B. as part of these ongoing efforts.”

The hiring of Cleary, which was first reported by The Wall Street Journal, comes as Puerto Rico tries to jump-start a flagging economy while also digging out from a mountain of municipal bond debt.

But there is no way they are going to dig out from that debt. In fact, as one would predict, their present economic problems are causing further problems—people are leaving to go find work elsewhere. Megan McArdle writes:

Labor mobility from Puerto Rico to the rest of the US, and particularly to Florida, has never been higher, while most of the migration in the other direction comes in the form of retirees, who are not exactly going to kick-start the economy. In fact, in terms of the labor force participation rate, they’re just going to make matters worse, on an island where only 1.2 million of the 3.4 million inhabitants are employed.

This is how economies die. Taxes go up on a dwindling working population, which causes it to dwindle further as more people leave to escape the taxes. Puerto Rico has no other option; it has to go bankrupt.

But according to McArdle, it really has no legal way to do so. Puerto Rico as a sovereign government does not have a “bankruptcy code under which to do an orderly reorganization.” This means Congress has an opportunity to provide such a framework and, in so doing, put in place a system that the states can use when their time comes.

So we should watch what happens to Puerto Rico since there are other states ready to follow their path.