First time default: Puerto Rico Default

Published: August 4, 2015

First time default: Puerto Rico Default, Puerto Rico has triggered the biggest municipal default in US history, risking years of bitter legal warfare with creditors and an austerity “death spiral” with echoes of Greece.

The island commonwealth finally ran out of money on Monday after a desperate effort to stay afloat, missing a final deadline for a $58 million payment – handing over just $628,000.

It implies a sweeping default on much of its $72 billion debt burden, equal to 100% of Puerto Rico’s gross national product (GNP) and more than five times the debt ratio of California or Texas.

The commonwealth is now in legal limbo, facing a well-organized pack of hedge funds that scooped up the debt at distressed levels and appears determined to extract maximum value in the courts, even if this means shutting down part of the island’s education system and social services.

Puerto Rico is not covered by the “Chapter Nine” bankruptcy code in the US, and therefore it cannot resort to the sort of orderly debt restructuring that helped the city of Detroit to get back on its feet after defaulting in 2013.

By a quirk of law, it does not enjoy the partial protection of full US states. At the same time, it is unable to draw on support from the International Monetary Fund since it is not a sovereign country.

“We don’t know how the bankruptcy is going to proceed. It could easily turn into a free-for-all,” said Desmond Lachman, a former IMF division chief now at the American Enterprise Institute.

“If the hedge funds press for their pound of flesh, they could drive the economy into the ground,” he said. “The more the economy tanks, the less tax they collect, and the more they have to tighten. It is crazy.”

“They are in a similar situation to Greece,” he said, “and this is what happens if you are asked to carry out too much fiscal adjustment in a fixed exchange monetary union. Their GDP has been shrinking by 1% a year for the last decade.”

A group of 34 hedge funds, led by Fir Tree Partners, among others, has recruited a team of former IMF officials to push their case that Puerto Rico is able to pay its debts if it reins in public spending.

They say the island is “massively overspending” on education, letting costs balloon by 39% over the past decade even though school enrollment has collapsed by a quarter. The island has already closed more than 100 schools.


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