NASA/NOAA GOES Project
On September 20, 2017, Hurricane Maria made landfall in Puerto Rico. It wreaked havoc across the island, leaving almost none of Puerto Rico unscathed. By the time the storm dissipated, it had killed nearly 50 people, displaced countless others, and destroyed the island’s power grid.
In all, Maria caused over $30 billion in damage to Puerto Rico and left many citizens without the necessities of life. As the world comes to grips with the immediate consequences of the storm, some analysts are also drawing attention to the longer-term economic problems that are sure to follow.
Puerto Rico’s biggest economic problem before the storm hit was debt, and Hurricane Maria is sure to have made that problem worse. Paying off $120 billion in debt is an overwhelming task in the first place. Paying that much debt off with a decimated infrastructure and a rapidly migrating workforce is next to impossible.
Why is Puerto Rico’s debt so big?
Up until about a decade ago, Puerto Rico was famous for its business-friendly tax policies, which attracted many American manufacturers to come to the island and open up shop. When those policies changed, many of these employers packed up shop and found new homes elsewhere.
Around the same time, the global economy shuddered as the “Great Recession” of 2008 took place, seemingly overnight. Nearly every economy in the world took a financial hit due to the recession, but most eventually recovered. Puerto Rico, absent an economic growth engine, never really did.
On top of that, the Puerto Rican government routinely spent far beyond its means. As a territory, Puerto Rico was still subject to many pieces of federal legislation regarding labor regulation and social welfare that forced increases in public spending. The government also found itself on the hook for over $50 billion in government pensions. After Puerto Rico lost many of its manufacturers, the government became the island’s largest domestic employer.
One might expect that taxes would pay for this type of domestic spending, but Puerto Rico also struggled with a tax revenue problem. For years, the island had been struggling with “brain drain.” Talented and educated young workers left Puerto Rico in droves in search of better lives elsewhere, shrinking Puerto Rico’s tax and economic base and making it even more difficult for the territory to become solvent.
To deal with increased spending and inadequate tax revenue, Puerto Rico did what any country would probably do: it borrowed. Financing spending with debt seemed like the only way for Puerto Rico to meet its obligations.
For a long time, Puerto Rican debt was in demand because of its unique legal status. Way back in 1917, the United States passed a law declaring that Puerto Ricans were United States citizens. Within the law was a provision: in order to empower the island to raise money, it could issue tax-exempt bonds. What made those bonds attractive was that the interest paid by the bonds was untaxable. That tax-free interest spelled out easy profits to organizations looking to make a buck.
Over the course of the next century, Puerto Rico’s debt bloated, causing many problems for the island. Even so, investors were happy to keep buying the bonds for a simple reason: states and territories in the United States could not declare bankruptcy.
In 2016, though, Puerto Rico ran out of money and stopped paying its bills. A breaking point was at hand, and that’s when everything went from bad to worse.
That year, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act, otherwise known as PROMESA. Among other things, PROMESA changed the rules on bankruptcy. The entire island was now capable of entering the bankruptcy process, overseen by a board appointed by the government.
In other words, the Puerto Rican bond bubble burst, and the party was over. PROMESA kicked off a process that will likely last for at least a decade and result in creditors receiving a fraction of their claims. Puerto Rican citizens are likely to feel the squeeze as infrastructure needs go ignored and retirees must forego their pensions. In the end, the country stands a chance at finally becoming financially solvent, but getting there won’t be fun.
The big picture is this: Puerto Rico’s total debt is more than $120 billion, about $34,000 per resident. Even if the bankruptcy process helps the island get its act together financially, Puerto Rico is still dealing with a shrinking economy and tax base.
That’s a bad situation by itself. Hurricane Maria made it a whole lot worse.
How did Hurricane Maria contribute to Puerto Rico’s debt crisis?
A Category 4 storm, Maria made landfall on Puerto Rico on September 20, 2017. Nearly 40 inches of heavy rainfall, gusts in excess of 110 miles per hour, storm surges, and flash flooding hit the island all at once. Almost all of Puerto Rico suffered effects from the storm as it made its way across the island, destroying homes, businesses, and lives along the way.
Nearly 50 people died in Puerto Rico due to the storm, and countless others lost their homes. The country’s power grid was decimated in the wake of the storm, and millions were trapped on the island without necessities. Aid distribution proved to be an ongoing challenge, as the state’s decimated infrastructure made it near impossible to reach many of those in need.
Estimates on the cost of rebuilding after Hurricane Maria vary, with some organizations pegging costs around $30 billion and others going as high as $90 billion.
For context, compare the costs of Maria to the costs of Hurricane Harvey in Texas and Hurricane Irma in Florida. Both of those storms took place not long before Maria made landfall, and both attracted major media coverage due to their size and severity.
In total dollars, Maria is actually the least costly of the storms. Estimates say that rebuilding after Harvey has cost just under $90 billion, while Irma sits just under $60 billion. Maria, by the more conservative estimates, will cost about $30 billion.
Remember, though, that the Puerto Rican government is already deeply in debt and on the cusp of lengthy bankruptcy proceedings. Unlike Texas and Florida, Puerto Rico does not have the benefit of significant tax revenue and a growing economy. In many ways, it still hasn’t recovered from the recession in 2008.
With that in mind, the next two comparisons shouldn’t be very surprising. If we look at the cost of rebuilding as a function of state GDP: Harvey will cost about 5% of Texas’s GDP and Irma will cost about 6% of Florida’s GDP.
Maria, meanwhile, will cost about 33% of Puerto Rico’s GDP.
If we divide the costs out per capita, the situation looks even grimmer. As already mentioned, one of the biggest hindrances on Puerto Rico’s economic growth is a declining population, especially the loss of the young and the educated. While both Harvey and Irma will cost about $3,000 per capita to their respective residents, Maria will cost the already struggling people of Puerto Rico about $10,000 per capita. That’s a lot of money that people just don’t have.
Simply put, it’s going to be very difficult for Puerto Rico to come up with the money to rebuild anytime soon, even with aid from the federal government. Even before Maria hit, the island was struggling with $120 billion in debt and kicking off a decade-long bankruptcy process. With an additional $30 billion necessary just to put the country back together in the wake of the hurricane, Puerto Rico is in full-on crisis mode.
What about forgiving Puerto Rico’s debt?
President Trump made headlines shortly after Hurricane Maria hit with a statement that he made while he paid a visit to disaster-stricken Puerto Rico. In an interview, Trump was asked about the island’s debt problem, to which he replied, “They owe a lot of money to… Wall Street, and we’re going to have to wipe that out.“
It’s unclear whether Trump will actually move forward to forgive any of Puerto Rico’s debt, but the debate put a finer point on a simple fact: the long-term effects of Hurricane Maria aren’t just to Puerto Rico’s infrastructure or the island’s environment. Once the power grid is back online and the roads cleared, Puerto Rico will be dealing with the economic devastation of Hurricane Maria for a long time to come.
There are lessons here for debtors and creditors both.
Debtors need to remember that taking on debt puts them in a precarious financial position. The more debt you have, the more vulnerable you are when disaster strikes. In addition, you never know when disaster will strike. Eliminating debt to the greatest degree possible gives you (and a territory) a much stronger foundation to deal with the unknown.
Creditors (and investors) need to remember that lending always comes with risk. While some investments will always be less risky than others are, no investment is ever going to be a sure thing. You never know when a force of nature is going to come out of nowhere and disrupt your plans.