Puerto Rico Government Debt and U.S. Federal Government: Potential Assistance Tools and Policy Practice

by Arturo Estrella

Fundación Carvajal (October 2014)

For a copy of the full paper, click here

“We want to continue to hear firsthand the economic and

financial issues that are important for businesses and

families, and we will continue to do all that we can to

support local communities and decision makers

in advancing good economic and fiscal outcomes.”

— William C. Dudley, President of the

Federal Reserve Bank of New York,

An Update on the Competitiveness of

Puerto Rico’s Economy, July 31, 2014

Highlights. Even a cursory examination of U.S. government actions during the recent financial crisis and economic slowdown in the United States leaves no doubt that the federal government has a multitude of tools at its disposal to confront financial disruptions and to attempt to mitigate their adverse effects. Leading the way during this crisis, as well as in various other crises over the last century, were the Federal Reserve System and the Treasury Department. The U.S. legal system has provided these agencies with an evolving set of powers that allow them to step in when crisis management is required. The goal is generally to avoid systemic problems, referring to repercussions of financial crises that have the potential to affect large segments of the financial markets or of the real sectors of the economy.

In any given crisis situation, questions arise as to whether the federal agencies should intervene from a policy perspective, whether they have the capacity – legal, financial, etc. – to attack the problems, and whether they have the tools that are required in the particular case at hand. The recent financial crisis provides many examples that shed light on these questions. What was the reasoning for the Federal Reserve and the Treasury to intervene in some cases but not in others? Were policy tools readily available or did they have to be constructed? Were statutory and regulatory powers sufficient to meet the challenges?

The history of Federal Reserve and Treasury Department intervention in past financial crises suggests that these agencies are driven by one important general principle: when there’s a will, there’s a way. Only a handful of the policy tools that were employed by these agencies in the financial upheavals of 2008 were previously available. The first step was to conclude that the situation was sufficiently serious to warrant intervention. The next question was, what kind of intervention? Here the Federal Reserve and the Treasury took somewhat different paths. Whereas the Federal Reserve concluded that it already had the legal and regulatory powers to address various problems, the Treasury sought new federal legislation that would enable the agency to take dramatic steps.

Discussion of the debt crisis in Puerto Rico has been ongoing for years. Substantive progress has been made by the government of Puerto Rico in addressing fiscal imbalances and by the investing public in an attempt to stabilize the situation and forestall further deterioration. The intent of this paper is to contribute to that discussion, but to contribute in a very specific way by providing detailed analysis of the legal and regulatory framework for Puerto Rico and the federal authorities as well as a review of past policy practice to gauge the feasibility of the ideas discussed, at least on a preliminary basis.

The analysis shows that there are various possible ways in which the federal government could assist Puerto Rico, and that in fact it is important that there be various elements to deal with different facets of the problem. These possible solutions should enter the public discussion and should be considered seriously by the local and federal authorities. Just as important is the need to clarify the situation of Puerto Rico as a Commonwealth in the overall global financial structure and in the internal administrative structure of the United States. The paper has identified some important questions that should be addressed by federal authorities in the search for solutions.

In light of the foregoing analysis, we come back to the basic question raised by New York

Federal Reserve Bank President William Dudley in his offer of help to Puerto Rico, what can the Federal Reserve – and more generally the federal government – do to assist the

Commonwealth and the people of Puerto Rico in these trying times? The fact that Puerto Rico is generally designated in Federal Reserve regulation as a state and as part of the Second Federal Reserve District opens the door to certain types of actions that federal authorities may take in the case of domestic financial crises. Moreover, the proven capacity of federal authorities to come to the aid of troubled sectors of the economy in past situations and their ability to work effectively within the legal framework or to change it if necessary should be a source of comfort.

Most importantly, the federal government and its agencies need to demonstrate the same will to find solutions that has been applied in the past to so many cases, domestic and foreign, a sample of which has been considered here. History shows that when the will is there and the situation is deemed sufficiently important, effective solutions have been found either within the existing legal structure or by advancing that structure further to tackle new problems.

http://sincomillas.com/wp-content/uploads/2015/10/Estudio-Fundaci%C3%B3n-Carvajal.pdf

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