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Puerto Rico Needs A Better Debt Deal

Oct. 10, 2018 6:29 AM ET6 Comments
Desmond Lachman profile picture
Desmond Lachman

History is littered with examples of ill-designed debt restructuring exercises that soon unraveled at great economic and human cost. Judging by the recently agreed debt restructuring arrangement for Puerto Rico's sales tax-backed bonds (COFINA), the island's economy risks joining those ranks.

Students of the University of Puerto Rico protest as a meeting of the Financial Oversight and Management Board for Puerto Rico is taking place at the Convention Center in San Juan, Puerto Rico March 31, 2017. Picture taken March 31, 2017. REUTERS/Alvin Baez

The COFINA restructuring doesn't go nearly far enough. It saddles Puerto Rico with escalating debt payments for the next 20 years, even though the economy has been in a decade-long slump. It also sets a dangerous precedent. If Puerto Rico's government and the oversight board created by Congress agree to similar terms with creditors who hold General Obligation bonds, it will be just a question of time before the commonwealth is forced to default yet again or curtail public pension payments upon which more than 325,000 workers depend.

By far, the most important condition for a successful debt restructuring is a realistic assessment of the economy's growth potential and its capacity to repay its debtors. Overly optimistic assessments of those prospects are a sure recipe for failure. They set up the economy for another debt restructuring and, as the economy labors under the weight of a debt overhang, they undermine investor confidence.

Anyone doubting the adverse consequences of such unrealistic assessments of an economy's ability to pay might want to look at Greece's recent sorry experience.

The Greek economy has paid dearly for the failure of the International Monetary Fund in 2010 to recognize that Greece had a solvency problem rather than a liquidity problem, and that its economy was likely to contract sharply by attempting draconian

This article was written by

Desmond Lachman profile picture
Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.

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