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The Puerto Rican Debt Crisis

Paper Session

Sunday, Jan. 5, 2020 10:15 AM - 12:15 PM (PST)

Marriott Marquis, Grand Ballroom 10
Hosted By: American Economic Association
  • Chair: Jay Shambaugh, George Washington University and Brookings Institution

What Went Wrong?: The Puerto Rican Debt Crisis, The “Treasury Put" and the Failure of Market Discipline

Robert Chirinko
,
University of Illinois-Chicago
Ryan Chiu
,
University of Illinois-Chicago
Shaina Henderson
,
University of Illinois-Chicago

Abstract

What went wrong? Why did seemingly rational bond investors continue to purchase Puerto Rican debt with only a modest risk premium, even though the macroeconomic fundamentals were dismal? Given gloomy macroeconomic fundamentals and relatively low risk premia, investors were either stunningly myopic or Puerto Rican debt was implicitly insured by the U.S. Treasury. The rational investor model rules out the former hypothesis.
This project examines the latter hypothesis, which we label the “Treasury Put.” The expectation of a federal bailout was perfectly reasonable given past behavior by the Federal Government, especially the prior bailout of the city of New York. Evaluating the Treasury Put hypothesis with a minimal set of assumptions is possible given two fortuitous features – a unique characteristic of Puerto Rican bonds and a “seismic shock.” Puerto Rico issued both uninsured and insured general obligation bonds. These bonds were issued on the same day and, in many cases, with the exact same maturity. These features allow us to compute accurately the risk premia on Puerto Rican bonds. The second feature was the non-bailout of the city of Detroit in 2013 that effectively extinguished the Treasury Put. Puerto Rican risk premia were stable before the Detroit bankruptcy and bracketed by the risk premia on Corporate Aaa and Baa bonds. However, after the Detroit bankruptcy, risk premia rose dramatically, thus documenting the existence of a sizeable Treasury Put and a significant misallocation of capital to Puerto Rico.

An Analysis of Puerto Rico's Debt Relief Needs to Restore Debt Sustainability

Pablo A. Gluzmann
,
CEDLAS (FCE-UNLP) & CONICET
Martin M. Guzman
,
Columbia University
Joseph E. Stiglitz
,
Columbia University

Abstract

This paper makes two contributions. First, we examine the macroeconomic implications of Puerto Rico’s Fiscal Plan that was certified in March 2017 for fiscal years 2017-18 to 2026-27. Second, we perform a Debt Sustainability Analysis (DSA) that incorporates the expected macroeconomic dynamics implied by the Fiscal Plan in order to compute Puerto Rico’s debt restructuring needs. We detect a number of flawed assumptions in the Fiscal Plan that lead to an underestimation of its contractionary effects on the island’s economic activity. We conduct a sensitivity analysis of the expected macroeconomic dynamics implied by the plan that allows us to construct more realistic scenarios of Puerto Rico’s debt restructuring needs. We show that the island’s current debt position is unsustainable, and compute the necessary debt relief to restore sustainability under different sets of assumptions. The paper offers general insights for performing a macro-consistent DSA.

United States Multinationals in Puerto Rico and the Repeal of IRS Section 936 Tax Exemption for United States Corporations

Zadia M. Feliciano
,
City University of New York and NBER
Andrew Green
,
City University of New York

Abstract

Puerto Rico, the Commonwealth Island and unincorporated territory of the United States, was placed under a fiscal Oversight Board by the U.S. Congress in 2016. Unable to pay $72 billion it owes to bond holders, Puerto Rico’s Government and the Oversight Board filed for court proceedings under Title III of the Puerto Rico Oversight, Management and Economic Stability Act, similar to Chapter 9 of the US Bankruptcy code. The origins of the crisis in Puerto Rico have been attributed in part to the phase out of the IRS Section 936 tax exemption program for U.S. corporations from 1995 to 2005 and its elimination in January 2006. Using industry panel data, compiled from the IRS Statistics of Income for U.S. Possessions Corporations, the U.S. Economic Census for Outlying Areas, and the mainland U.S. Economic Census, we analyze the effects of the phase out and elimination of Section 936 on the number of establishments, value added, employment, and wages in Puerto Rico’s manufacturing. Our results show the elimination of Section 936 had the effect of decreasing average manufacturing wages by 16.7%, and decreasing the number of manufacturing establishments by 18.7% to 28.0%

The Transmission of Quasi-Sovereign Default Risk: Evidence from Puerto Rico

Anusha Chari
,
University of North Carolina-Chapel Hill and NBER
Ryan Leary
,
Brattle Group
Toan Phan
,
Federal Reserve Bank of Richmond

Abstract

Puerto Rico’s unique characteristics as a U.S. territory allow us to examine the
transmission of quasi-sovereign default risk to the real economy. We document a negative relationship between increased default probabilities and employment growth in
government-demand-dependent industries. The negative relationship strengthens when
the government undertakes austerity measures. In addition, fiscal austerity reduces
output growth via a local fiscal multiplier effect. Overall, we provide evidence for a
novel demand-driven transmission mechanism of sovereign default risk that operates
through austerity risk and government demand dependence.
Discussant(s)
James Poterba
,
Massachusetts Institute of Technology
Daniel Gros
,
Center for European Policy Studies (CEPS)
James Hines
,
University of Michigan
Laura Alfaro
,
Harvard Business School
JEL Classifications
  • H0 - General
  • G1 - General Financial Markets