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Old 05-09-2016, 06:06 PM
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Mary Pat Campbell
Join Date: Nov 2003
Location: NY
Studying for duolingo and coursera
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After missing relatively small bond payments last August and this January, Puerto Rico's public sector defaulted on at least $367 million of principal due May 1. As a consolation, investors did receive $9 million in interest from the defaulting entity, Puerto Rico's Government Development Bank.

The fact that Puerto Rico even has a Government Development Bank should raise an eyebrow. State-owned banks are not a major feature of the mainland US economy, perhaps because failures of state banks contributed to a number of state bond defaults in the 1840s. Since the US didn't take over Puerto Rico until 1898, the island was not around to learn that lesson. The GDB is one of over fifty public corporations dominating Puerto Rico's economy. Others control the island's electricity, water, and sewer services.

Public corporations date back to the 1940s and largely owe their existence to the efforts of Rexford Tugwell. "Red Rex" was a Columbia University economist who was sold on the virtues of the Soviet way when he visited Stalin's Russia in 1927. He went on to play a leading role in implementing Roosevelt's New Deal. In 1941, FDR appointed Tugwell as Puerto Rico's governor, where he applied a similar state-led economic model. While much of the New Deal was unwound on the mainland, Puerto Rico's public corporations persisted on the strength of borrowed funds.

Puerto Rico's 1917 congressionally-imposed constitution limited Puerto Rico's central government and municipal debt to 7 percent of assessed property values. It also mandated a balanced budget. These limits did not apply to public corporation debt, and these entities started borrowing liberally.

A new constitution ratified in 1952 as amended in 1961 relaxed constitutional limits on Puerto Rico central government and municipal borrowing. A major cause of this relaxation was a mistranslation of balanced budget language in the 1952 constitution. While the English version instructs the legislature to balance revenues and expenditures, the Spanish translation of revenues was closer to "resources". The Puerto Rico government interpreted "resources" broadly, even including bond proceeds. It thus became possible to "balance" the budget with borrowed funds.

By the early 1980s, public sector debt had reached 82 percent of GNP—not far below today's level of about 100 percent. Puerto Rico muddled along with high debt levels until recently, when a long-lasting recession, out-migration, a string of unbalanced budgets, and loss of bond market access triggered the current crisis.

Now that Puerto Rico's crisis has deepened, House Republican leadership and the Obama Treasury Department have reached a broad agreement on what needs to be done. The plan, embodied in HR 4900, combines a new legal process for debt restructuring with a federal oversight board to help Puerto Rico balance its budget.

Oversight boards are undemocratic, but they succeeded in New York and Washington, DC. As I discussed in a recent paper for the Mercatus Center at George Mason University focusing on the historical causes and potential solutions for the crisis, this formula also proved effective in Newfoundland—which was transformed from an insolvent British Colony to a debt-free province of Canada by an appointed government.


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