By Desmond Lachman
It is said that those who do not learn from history are doomed to repeat it. Sadly, this adage appears again about to be proved true by the way in which the United States Congress is dealing, or more correctly not dealing, with Puerto Rico’s financial and economic crisis. Congress is acting in a manner apparently oblivious to Greece’s recent disastrous debt experience despite the many close parallels between the Puerto Rican and the Greek crises.
While there are certainly many differences between Puerto Rico and Greece, there are a number of striking similarities. Those similarities suggest that Congress would do well to look at Greece’s experience when framing a policy response to the island’s deep economic troubles. Those troubles are now reflected in a 10-year economic slump, a 45 percent domestic poverty rate and an ever-increasing number of Puerto Ricans leaving the island for the mainland.
Over the past decade, like Greece before it, Puerto Rico took advantage of favorable financial market conditions (in Puerto Rico’s case, created by ample Federal Reserve liquidity and by highly generous tax exemptions on interest earning on its bonds) to borrow very heavily in the U.S. capital market. Like Greece, too, Puerto Rico made poor use of that borrowing. It did so by allowing major public finance imbalances to build up and by delaying real structural economic reforms that might have galvanized its ailing economy.
Like Greece, Puerto Rico’s economy has been in a prolonged slump owing to mismanagement and to Congress withdrawing generous manufacturing tax preferences. Perhaps most important of all, similar to Greece, Puerto Rico does not have a currency of its own. As a result, like Greece, Puerto Rico too cannot use interest-rate or exchange-rate policy as an offset to the contractionary effects of budget tightening on aggregate demand.
In a refreshing moment of candor, the International Monetary Fund recently owned up to two very costly mistakes that it had made in the handling of the Greek economic crisis. Those mistakes contributed importantly to Greece now experiencing an economic depression on the scale of that experienced by the United States in the 1930s. The first mistake was not to recognize in 2010 that Greece was suffering from a solvency, rather than a liquidity, crisis. This led the IMF down the path of demanding from Greece an excessive amount of budget austerity within a euro straitjacket that precluded currency devaluation. The second mistake was that the IMF grossly underestimated the degree to which budget tightening could have a deleterious impact on the Greek economy. This mistake caused the IMF to be consistently too optimistic in its Greek economic growth forecasts.
The collapse of the Greek economy has had devastating social consequences for the Greek population as reflected in a youth unemployment rate well above 50 percent. It also has hardly been good for Greece’s bondholders. In the end, as Greece’s capacity to pay was highly diminished by its shrinking economy, Greece’s bondholders were forced in 2012 to accept a 75 percent write-down in the present value of their loans in what was the largest sovereign debt default on record.
It is against this background that one has to be dismayed that the U.S. Congress is now repeating with Puerto Rico very much the same mistakes that the IMF made in its handling of Greece’s sovereign debt crisis. Rather than embracing the Obama administration’s recent proposal for affording Puerto Rico with a comprehensive bankruptcy mechanism that would allow for an orderly restructuring of Puerto Rico’s 18 different debt issues, Congress is now floating the idea of a series of band-aids for the island in the form of short-term liquidity relief. It is doing so in the mistaken belief that the island is suffering more from a liquidity than a solvency problem.
Similarly, rather than recognizing that bankruptcy is a necessary condition for the orderly restructuring of Puerto Rico’s $72 billion debt mountain, Congress is now toying with the idea of imposing some form of 1975 New York-style Control Board on the island that would require from the island major budget adjustment. It is doing so despite the fact that the island is already in the deepest of economic recessions and despite the highest of probabilities that, as was the case in Greece, excessive budget austerity in a U.S. dollar straitjacket would drive the Puerto Rican economy further into the ground.
A basic lesson that U.S. policymakers should draw from Greece’s sorry experience is that if debt cannot be paid it will not be paid. Pretending that Puerto Rico’s debt will be paid, by demanding of it major budget belt tightening without orderly debt restructuring, will certainly not be in Puerto Rico’s economic interest. Greece’s economic experience would suggest that it would also not be in the collective interest of Puerto Rico’s creditors since a further decline in Puerto Rico’s economy will only further impair its ability to repay its debts.
