President Trump and various administration officials have expressed concern that Puerto Rico's inability to recover from the devastation of Hurricane Maria is compounded by its financial emergency. They are correct. The commonwealth has defaulted on more than $70 billion in public debt and has a significant pension shortfall, as well. This will make financing a recovery much more difficult.
Puerto Rico's situation is not unique. Philadelphia, Detroit, and the District of Columbia have all undergone periods of financial emergency. Puerto Rico's situation is most analogous to that of the District of Columbia's. Both Puerto Rico and Washington function as if they were state governments but have limited sovereignty.
When Washington experienced its financial emergency, in the 1990s, Congress passed the Financial Responsibility and Management Assistance Act, which created an oversight board and also rebalanced federal and local obligations, including giving the federal government responsibility for prisons and the district's pension obligation. Standby authority for both short- and long-term borrowing was made available to the district from the federal Treasury.
In June 2016, Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), which created a Fiscal Control Board but provided no access to financial assistance. With the July 2016 suspension of payments of debt service, Puerto Rico essentially declared bankruptcy and the matter of repayment of obligations is now before the federal courts for resolution.
It is going to be very difficult, if not impossible, to provide current services and resolve the claims of various debt holders while restoring the island from the devastation of Hurricane Maria. The economy of the island and its tax base both suffered grave damage.
It is highly likely that there will be additional congressional action. This may come as part of a larger set of bills that are expected to move forward in December. The assistance would be targeted at restoring the public infrastructure that was destroyed but it is unlikely to be directed toward debt restructuring. This will continue to leave Puerto Rico in a vulnerable position.
We have both been presidentially appointed federal officials and believe that, as the senior government to Puerto Rico, the federal government has a responsibility for providing a debt restructuring mechanism along with the funds for reconstruction. This could be done by allowing the commonwealth to issue new taxable bonds whose principal and interest was guaranteed by the federal government. These bonds would be used to replace existing tax-exempt bonds under the aegis of the courts and PROMESA. While the process would be extremely complicated, the federal guarantee would be a financial "light at the end of the tunnel" for debt restructuring.
The commonwealth would be charged a fee for the guarantee similar to those charged by municipal bond insurance firms. This would result in a "negative subsidy," or cash benefit, to the federal government. The budget scoring should result in a budget saving if the guarantee is properly structured. And there is an additional benefit to the federal government: Replacing tax-exempt debt with taxable debt would provide additional revenue to the Treasury.
Using the guarantee on some or all of the outstanding debt would be a choice that the commonwealth could make. It is impossible to estimate the savings that the commonwealth would receive in such a restructuring. We have been informed that the average interest rate on current debt is about 6 percent. The current 30-year federal Treasury bond rate is about 2.9 percent. Various factors, such as the guarantee fee and the spread to treasuries that these taxable Puerto Rico bonds would require, would be necessary to know before making an estimate of the benefit to the commonwealth.
The tool we propose is not a panacea and will not be sufficient to restore and restructure. In addition, there would need to be considerable federal aid, new economic development, and the sweat and toil of many for Puerto Rico to regain its sobriquet, "The Island of Enchantment." We look forward to that day.