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Why Iowans should care about a Puerto Rico bailout

What’s the matter with Puerto Rico, and why should Iowans care?

It's become increasingly clear that Congress will soon need to provide some sort of assistance to the U.S. Territory. The island has weathered a decade of recession, holds $72 billion in debt it cannot fully repay, and its pension plan verges on bankruptcy.

Widespread agreement exists that something must be done, but no easy fix has emerged. As chairman of the Senate Judiciary Committee, Republican Sen. Chuck Grassley, sits at the epicenter of this crisis. Iowa taxpayers should closely watch how Congress resolves this issue because it could end up worsening the state’s finances.

Puerto Rico wound up in its fiscal predicament by borrowing money to postpone tough tax and spending decisions whenever possible—a strategy Iowans would recognize as bond measures have ballooned state debt in recent years.

Until recently, Puerto Rico could borrow at bargain basement rates, thanks to generous tax breaks its lenders receive on interest and because the commonwealth’s constitution promises that its general obligation bondholders will be paid back ahead of all other creditors. Eventually, lenders realized that they might not be repaid, and capital markets demanded sharply higher interest rates before they simply turned off the spigot.

One proposed solution is to allow Puerto Rico to file Chapter 9 bankruptcy. Under Chapter 9, a state’s municipalities and public agencies can reorganize finances, but it does not apply to the general obligation debts. Since more than two-thirds of the island’s debt would be covered by Chapter 9, this should be sufficient to help ameliorate the crisis. However, the island’s government, along with the U.S. Treasury, propose a legislative change that would allow all of its debt to be covered by bankruptcy protection—an unprecedented step that essentially negates the constitutional promise.

The problem this would create for Iowa is that investors will assume that an all-inclusive bankruptcy protection bill for Puerto Rico might serve as a template for Iowa if some day it finds itself unable to pay its bills. That perception would make it more costly for the state to borrow money and could potentially hasten the day of fiscal reckoning.

Iowa’s response should be to moot the outcome of the Puerto Rico rescue and undertake its own budget reforms, which would entail spending cuts and smarter spending decisions as well as pension and debt reform. Iowa might also consider ways to raise revenue, at least in the short run. Everyone in Iowa must sacrifice, including government employees.

Iowa is among a majority of states that allow municipalities to file Chapter 9 bankruptcy, but Iowa prohibits including collective bargaining agreement costs or bond issues (the majority of most municipal debt) in Chapter 9 proceedings.

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Iowa is in much better shape fiscally than Puerto Rico, but long-term issues loom on the horizon. The state’s budget has ballooned from $4.3 billion in 2005 to $7.3 billion in 2015 — a 70 percent increase in just 10 years. Meanwhile, our state’s economy grew at just 12 percent over the same time. As politicians spend more, we’re also racking up record levels of debt.

In 2015, Iowa carried $15.3 billion in debt, including obligations of local governments and state agencies—a 76 percent increase from 2005, when the state owed $8.6 billion. That comes out to a debt of $4,885 per Iowan.

Des Moines holds the largest debt by city at just over $450 million, which amounts to over $2,200 per person. Citizens of Iowa's capital also shoulder the debt of Polk County, the largest in the state at nearly $309 million. Coralville holds the most debt per capita at $14,747— $279 million for just 18,900 residents.

That debt doesn’t even include unfunded liabilities from Iowa’s public pension, IPERS. According to its own figures, the system had an unfunded liability of $5.45 billion in 2015, up from $2.28 billion in 2005, and that’s probably an understatement. The market-value method, commonly used by investment ratings firms, skyrockets IPERS' funding shortfall to $33.9 billion.

Add it all up, and Iowa holds a $49.2 billion debt burden — $15,750 for every man, woman and child in the Hawkeye State.

It doesn’t take any special expertise to recognize Iowa’s fiscal fumbles and correct this mess. Iowans are waiting for elected leaders to stop playing chicken with financial realities and begin the monumental task of fixing the state’s finances. Until then, residents of Iowa should tell the federal government to reconsider allowing Puerto Rico to wipe away its debt, making Iowa’s long-term fiscal recovery all the more difficult.

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Jeff Patch operates Iowa Intelligence, a Des Moines-based research firm. Ike Brannon is president of Capital Policy Analytics.

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