Puerto Rico’s fiscal crisis reached a low point last week when the territory filed for what’s being called a “form of bankruptcy." But what does that really mean? Can troubled states like Illinois do the same?
The short answer is no – Puerto Rico’s situation is unique and the U.S. Constitution doesn’t allow states to file for municipal bankruptcy, what’s called Chapter 9 protection. That protection to restructure debt is only afforded to lower levels of government like cities, counties and special districts. And even in those cases, only about half of states allow their local governments to declare Chapter 9 bankruptcy.
Puerto Rico’s action is thanks to a rescue bill passed in Congress last year. That legislation outlined a path for the commonwealth to restructure its debt while under the watchful eye of a financial oversight board. The bill is called the Puerto Rico Oversight, Management, and Economic Stability Act, or Promesa. It applies to all territorial governments but Puerto Rico is the first test case.
When Promesa was passed, the commonwealth was running out of money, its bonds had long been at junk status and proposals to renegotiate much of its outstanding $70 billion in bond debt were rebuffed by bondholders.
Since the rescue bill went into effect, the fiscal oversight board has approved the government’s spending plan and officials have been trying to negotiate with creditors to restructure the island’s massive debt. However, the spending plan sets aside very little money for paying creditors. Not surprisingly, those negotiations have not progressed.
Meanwhile, the rescue bill also gave Puerto Rico a temporary stay from bondholder lawsuits regarding its defaulted debt. But that stay ended on May 1. Having shown it made an attempt to renegotiate in good faith with creditors, Puerto Rico almost immediately petitioned for relief under Title III of Promesa. That gives it protection to restructure its debt in federal court, much like Chapter 9 does for municipal governments.
Despite the fact that Promesa is specific to territories, some have worried that it could open up a slippery slope for fiscally troubled states. After all, if Congress made a new law for Puerto Rico, what’s to stop it from doing that again? The commonwealth’s former governor, Antonio García Padilla, warned last year during a speech in Washington, D.C. that Puerto Rico is “only ahead of the curve – the curve that looms for many states and municipalities.”
That may be true but fiscally troubled governments like Illinois have a long way to fall before it reaches anything like what is facing Puerto Rico now. The commonwealth has been in a recession since 2006, it has repeatedly borrowed money to pay its bills, its bonds have long been rated at junk status and its tax base has shrunk as residents have fled for the mainland. No U.S. state in the modern era has ever faced that combination of problems.