This article was published by The McAlvany Intelligence Advisor on Wednesday, February 3, 2016:
When Columbia law school graduate Franklin Roosevelt became president in 1932 he asked Rexford Guy Tugwell and two other Columbia professors to be his “brain trust.” Although Tugwell could never have been proven to be a member of the Communist Party USA, his fondness for centralized planning and his violent rejection of the free market informed his efforts to develop the New Deal.
He was a pure-bred hard-core collectivist who was enamored with Stalin’s centralization of agriculture in the Soviet Union, saying that it was the path to efficient food production.
When Roosevelt appointed Tugwell Governor of Puerto Rico during the Second World War, Tugwell seized the opportunity to collectivize the private companies generating electricity and formed the Puerto Rico Electric Power Authority (PREPA). PERPA provided free electricity to municipalities to make up for the taxes lost when those private companies disappeared into Tugwell’s collectivist maw.
When something is free, the demand for it is unlimited – something that Tugwell either didn’t consider or didn’t care about. Aguadilla, a small town located on the northwestern tip of the island, is a microcosm of Puerto Rico’s problems. Formerly a fishing village, it now is the home of industrial high-tech firms like LifeScan, Micron Technology, Symmetricom, Honeywell, and Hewlett Packard. Other industries there are in rubber, leather, textiles, steel, wood, machinery, and food processing.
What makes Aguadilla unique is that it has consistently run budget surpluses, even going so far as to reward its citizens free tickets to the city’s water park. How does that happen on an island that has been borrowing to pay its bills for decades and suffering recession since 2005?
The electricity is free, that’s how. And not just Aguadilla. PREPA has been giving free electricity to all 78 of the island’s municipalities, to many government-owned enterprises, and even to some private for-profit businesses. But Aguadilla is the poster child for taking advantage of free electricity. It has 19 city-owned restaurants, a hotel, a water park (the largest in the Caribbean), a minor-league baseball stadium (complete with floodlights for night games), and a waterfront shimmering with dancing water fountains and glimmering streetlights.
It also has an ice-skating rink, complete with a disco ball and laser lights.
Keeping all these amenities glowing costs a fortune, but since it’s free, what’s the incentive to limit or restrict them?
The original plan was that any time a municipality used more electricity than the taxes it would have received, it was supposed to pay for it. With the passage of time, however, the calculation became so complex that bureaucrats finally gave up on it. The result: hundreds of millions of dollars are owed to PREPA that it will never collect.
It’s taken decades, but the chickens have come home to roost. Last summer Puerto Rico’s Governor Garcia Padilla, faced with interest payments on some of the island’s enormous $73 billion debt, said the island is “out of money” and that unless the economy revives by some miracle, it would continue its “death spiral.”
In December he skipped making some other interest payments as well, and is now offering the solution to the island’s financial problems: stiff the bondholders who made it so easy for entities like PREPA to borrow and then give away massive sums without accountability or repercussions.
The island’s economy was never truly self-sufficient. It subsisted on tax laws that favored high-tech and pharmaceutical companies and “triple-tax-free” municipal bonds. Tourism was never a paying proposition and when those tax laws ended in 2006 they put 80,000 people out of work. That set in motion a recession that continues to this day.
But free money – or nearly free – was always available, especially following the Fed’s ZIRP, which forced yield-hungry investors to ignore the risks of buying Puerto Rico’s bonds and purchase an astonishing $125 billion worth of them (with Wall Street’s help, of course) over the next ten years. It was the same mentality that made Tugwell’s collectivist experiment work so well for so many years: if it’s free, or nearly so, let’s get some for ourselves.
But the inevitable laws of economics have kicked in, and have put Padilla into a pickle: sales taxes were just raised from 7 percent to 11 percent, 40 percent of the island’s population lives below the poverty level with one quarter of those with jobs already working for the government. Where else can he go?
Puerto Rico’s Senate President Eduardo Bhatia perfectly summed up the problem:
If the towns don’t get free energy [provided by the government since 1941], they’re going to have to pay for it by increasing their property taxes or something … the people will end up paying.
But what if they don’t have the money? Stiff the bondholders! Padilla offered a complex plan of exchange offers to present bondholders for new bonds, the essence of which would give them a 50 percent haircut. But that isn’t going down well, either. And since Puerto Rico is treated as a suzerainty, it cannot claim Chapter 9 bankruptcy.
So the end game of Tugwell’s socialist experiment that has turned Puerto Ricans into an island of dependents has now arrived. They are now learning two lessons: “When something cannot go on forever, it will stop,” and “Nothing is free except for the grace of God. Everything else comes with a price.”
New York Times: How Free Electricity Helped Dig $9 Billion Hole in Puerto Rico
Bloomberg: Puerto Rico’s Slide
The New American: Puerto Rico Defaults Today on Part of $1B Debt Payment