A November 3rd post on the New York Fed’s Liberty Street Economics blog focuses on the precarious fiscal situation of Puerto Rico, and takes a closer look at the impact of the alternatives the government of the Commonwealth of Puerto Rico might take to resolve the financial crisis.

Fed analysts note that this post updates their earlier estimates of Puerto Rico’s outstanding debt, and discuss the effect that various forms of bankruptcy protection might have on the island’s balance sheet.

Scale of Puerto Rico’s public sector debt

Puerto Rico

As can be seen in the table, Puerto Rico’s total public sector debt totals at close to $71 billion as of mid-2015. That represents nearly 103% of the Commonwealth’s Gross National Product. Keep in mind that this figure is all debt owed by the public sector, including the central government, municipalities and a range of public corporations. This total does not include the projected present value of net unfunded pension liabilities, estimated at around $44 billion, or another 64% of GNP.

Clark, and Orr highlight that total debt service payments for PR for the next five years average about $3.6 billion per year. This represents 5.2% of GNP (or a third of broad central government revenues as forecast under current law). Debt service this large is almost impossible for the Commonwealth to manage. The authors project that under the best case scenario, Puerto Rico will average $1.5 billion a year in revenues available for debt service over the next five years, less than half what they owe.

More on Puerto Rico restructuring options

Chapter 9 of the U.S. Bankruptcy Code provides a mechanism for the orderly resolution of debts of municipalities, but Chapter 9 doesn’t currently apply to Puerto Rico. The Commonwealth passed the Corporations Debt Enforcement and Recovery Act in 2014 to address this issue. However, a July 2015 federal Appeals Court decision ruled that the PR Recovery Act violates the Supremacy Clause (Article VI) of the U.S. Constitution.

Clark, and Orr suggest that a framework for an orderly restructuring process will probably involve a “bankruptcy-like” regime for the Commonwealth. In Chapter 9, “municipalities” are political subdivisions of states; but states themselves are not eligible to file for bankruptcy protection under Chapter 9. Thus, a direct application of Chapter 9 to Puerto Rico would allow for the possibility that the debts of the public corporations and agencies, along with municipality debt, would be protected from creditors.

These debts totaled $24-28 billion as of June 2015, representing around 40% of total PR debt. Clearly, a significant reduction or rescheduling of these debts would provide substantial relief. (The authors note that it is “less clear how some special kinds of debt like COFINA and the Commonwealth’s pension bonds would be treated under this version of Chapter 9. Deciding this would likely be a costly and time-consuming process.”)

Puerto Rico is not a state, however, so one alternative approach would be a mechanism that would apply to the obligations of the Commonwealth itself, instead of just to the debts of its subdivisions. This mechanism could include all $71 billion shown in the table, and would make moot any discussion of an obligation of the Commonwealth versus an obligation of a subdivision. A more comprehensive set of obligations would obviously provide notable debt relief, and an opportunity to spread the burden of restructuring across more creditors.