Sprinkled among the sun-kissed tourists on Southwest Airlines flight 982 sit a handful of families and a few young men and women who are leaving Puerto Rico with no plan to return.
The flight is one of dozens depleting the island of a most valuable resource: its residents. Puerto Rico’s population has been declining for a decade but that has accelerated as its financial and economic crisis bubbled up from simmer to boil.
Its population has fallen 9 per cent over the past decade, a loss that includes 200,000 working age adults — more than the entire population of Salt Lake City. In the past year alone, about 100,000 people have left the Caribbean archipelago, many of them bound for Florida, Texas and New York.
Kathy Beckman, a flight attendant with Southwest who jets between San Juan and Orlando, has seen the exodus from the US territory at first hand. “Very rarely are any of [the flights] empty.”
The fiscal collapse of Puerto Rico, which suffers under a debt and unfunded pension burden of more than $110bn, has prompted one of the largest migratory movements within the US in decades, demographers say.
“In so many ways this is a 21st century version of the Okies and the Dust Bowl [migrations] in the US in the 1930s,” says Harley Shaiken, chair of the Center for Latin American Studies at the University of California, Berkeley. “The difference is these people are crossing an ocean.”
The brain drain is acute and is having a severe effect on every aspect of Puerto Rican life. The island has lost paediatric doctors, and the island’s only air ambulance stopped services this year. Schoolteachers outside San Juan, the capital, have had to turn off the lights in the rain — a result of outdated and damaged fuseboxes.
Puerto Rico has admitted defeat in its battle to stay current on its debts and is preparing for restructuring talks with creditors. But none of the proposals by the US commonwealth or its lenders, including slashing its debts or an interest rate holiday, are likely to kick-start growth. Advisers to both sides concede that without being able to halt the economic rot — output has been in near-constant decline since 2007 — they could be back in negotiations within the next decade.
And that is before policymakers consider rapidly depleting federal funding for healthcare and the prospect of the end of a business tax that has provided roughly a fifth of the island’s revenue.
“Puerto Rico is not Greece or Argentina but it can get to Greece or Argentina [levels] if we do not act,” Alejandro García Padilla, the island’s governor, says in an interview at La Fortaleza, his official residence in Old San Juan. “The numbers are the numbers and they underscore what Puerto Rico needs. Something less may help in the short term but then there is a high probability that Puerto Rico will need a restructuring again.”
The fiscal crisis has its roots in the end of a package of US tax incentives in 2006 that had made Puerto Rico attractive for manufacturers. Introduced in 1976, the incentive brought a wave of US multinationals to the island, including Eli Lilly, Merck, Pfizer and Johnson & Johnson.
By the early 1990s more than a tenth of the jobs on the island had a direct connection to the subsidy, according to the US Government Accountability Office. But its phase-out prompted companies to slash jobs — increasing the effects of the global financial crisis.
Puerto Rico borrowed to keep services running and to try to stimulate growth. More than $28bn was added to its debt load between 2006 and 2014.
The island’s Government Development Bank funded a series of projects, including a $415m convention centre, golf courses and hotel projects, several of which failed. The GDB is now on the verge of collapse.
The exodus of residents is adding to the island’s downward spiral. Andrew Haughwout, a researcher with the Federal Reserve Bank of New York, warned that migration would “reduce things like [gross national product] growth and that will have negative implications on the fiscal situation and that has feedback into GNP”. Mr Haughwout says Puerto Rico’s economic decline will probably worsen.
“At some point the debt service burden becomes so great it is a deterrent to growth, it actually retards growth,” says Jim Millstein, founder of Millstein and Co, which is advising the commonwealth. “The people of Puerto Rico are voting with their feet. The economy is so stagnant that it is driving people off the island, to Florida and Chicago and New York.”
As part of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa, Spanish for promise), which was signed into law in June, Puerto Rico will have the ability to cut its debts.
Before its passage, Puerto Rico and other US territories did not have access to bankruptcy protections afforded to US cities and public corporations. The law created a seven-person board — four Republican and three Democratic nominees — to oversee the debt reduction plan. It will have the final say on the island’s budgets and can order public sector lay-offs or recommend privatisations.
“We don’t know if it will be a draconian board that starts disposing of government assets at fire sale, starts cutting government jobs and contracts, or if it will be more flexible and slower in taking those actions,” says Miguel Soto-Class, president of the Center for a New Economy, a Puerto Rico think-tank.
While the passage of Promesa reduced tension over debts, however, it inflamed arguments over Puerto Rico’s status within the US.
The issue is animating the island’s election campaign, in which the New Progressive party’s candidate for governor opposes Promesa. Ricardo Rosselló, an MIT graduate whose father was governor for eight years from 1993, has gained ground among voters who believe Promesa smacks of colonialism. Mr Rosselló says the island’s debts can be paid without Promesa — and he also supports changing Puerto Rico’s legal status as a territory to a state.
“[Mr Rosselló’s campaign] has publicly stated that the debt can be paid but it’s unclear what specific strategy they’ll pursue come January if elected,” says Héctor Cordero-Guzmán, a professor at Baruch College, New York. “They haven’t come up with a lot of details.”
Mr Rosselló will face David Bernier of the ruling Popular Democratic party. Analysts with Height Securities, an investment firm, note that polls show Mr Rosselló’s party could make a sweep of the Puerto Rican House, Senate and governorship.
Creditors met in Citigroup’s headquarters in Manhattan in June to resume the difficult talks over restructuring Puerto Rico’s debt. What was expected to be an intimate gathering of the largest holders of the island’s debt, including Franklin Templeton Investments, Oppenheimer and Goldman Sachs, instead included dozens of bondholder representatives, many in competing positions. They have yet to formally meet again.
When they do, negotiations will be tense. A fight is under way to determine where each creditor ranks within the near $70bn debt mountain, a point complicated by the number of bond-issuing agencies. Eighteen Puerto Rican authorities have issued debt, including the water and power utilities and the transport and highway authority, as well as obligations that were meant for the commonwealth’s general use and are backed by constitutional guarantees.
In July, when thegovernment missed nearly $1bn of payments, it paid off other lower-rated debts instead of paying general obligation bond holders. US investors fear it could set a dangerous precedent in the municipal bond market, as states with large pension obligations face the threat of insolvency.
The island has been hit with more than half a dozen lawsuits from bond insurers and hedge funds, including Aurelius Capital Management and Monarch Alternative Capital. These have been served before the expiration of a stay of litigation, which prevents lawsuits against the commonwealth while Promesa’s oversight board gets up and running.
Despite the defaults, Puerto Rican bonds have been among the best performing in the municipal bond market this year, according to Barclays. The bonds, which have returned 8.7 per cent in 2016, are exempt from federal, state and local taxes. The tax benefit was — for a time — a boon to municipal bond fund managers across the US who often struggled to find enough of a given state’s bonds to fill a portfolio.
Bondholders are waiting to see who will make up the oversight board, with Richard Ravitch, a former lieutenant-governor of New York, and Anthony Williams, former chief financial officer of Washington DC, among the names being circulated as possible appointees. Several fear a repeat of the bankruptcy proceedings in Detroit or Stockton, California, when creditors suffered heavy losses.
Although Promesa protects bondholder interests, it also gives the commonwealth “cramdown” provisions that give the oversight board the ability to seek court permission to force deeper cuts on bondholders. It is the part of the law advisers to Puerto Rico expect to rely on significantly to cut its debt.
“If … what we proposed is in their best interest and it follows Puerto Rican constitutional law, the judge can force it down,” Mr Millstein says. “This is exactly what happened in Detroit.”
While politicians and bondholders strive to find a solution to its debt problems, the exodus from Puerto Rico is expected to continue, damaging the prospects for growth.
The New York Fed recently warned that “if people continue to leave the island at the pace that has been set in recent years, the economic potential of Puerto Rico will only continue to deteriorate”.
Bondholders fear the focus on pensions
Puerto Rico’s problems have yet to infect the $3.7tn municipal bond market, a vital source of funding for infrastructure projects for US cities and public agencies.
But the island has become a bellwether of how US municipal bankruptcies might unfurl, as states and major cities — including Illinois, New Jersey, Connecticut and Kentucky — grapple with outsized debts. At present, and unlike cities and municipalities, states do not have access to federal bankruptcy protections. Investors will therefore be scrutinising proceedings in Puerto Rico, which under Congressional authorisation gained access to bankruptcy protections similar to those under Chapter 9. The fear is that a precedent is being created where pensioners rank above bondholders.
In Detroit, pensioners gave up annual cost-of-living increases and took a cut in monthly cheques while bondholders faced recoveries of less than 74 cents on the dollar. Puerto Rico’s latest proposal to bondholders envisaged haircuts of 19 to 40 per cent of holdings.
“If in practice [pensions] are getting priority treatment, and if you take the next step by making this a matter of law … it springs $3.5tn to $4tn [of pension priorities ahead of bonds],” says Stephen Spencer, of Houlihan Lokey, which is advising bondholders of Puerto Rico’s electricity utility. “That is equivalent to the entire municipal bond market. That is an enormous impact on the creditworthiness of municipal bonds.”
Defaults on municipal bonds are still rare and often well telegraphed, factors that have attracted overseas investors into the market, even though they do not enjoy special tax benefits. But the rising costs of pensions, especially as interest rates fall, is another funding headache for cities and states.