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A look at the latest twist in Puerto Rico’s debt saga

People carry a large Puerto Rican flag as they protest looming austerity measures amid an economic crisis and demand an audit on the island's debt to identify those responsible, in San Juan, Puerto Rico, Monday, May 1, 2017. Puerto Rico is preparing to cut public employee benefits, increase tax revenue, hike water rates and privatize government operations, among other things. (AP Photo/Danica Coto)

A look at the move by Puerto Rico’s government to seek a form of bankruptcy protection as the U.S. Caribbean island territory struggles to emerge from a prolonged debt crisis and recession.

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DID PUERTO RICO JUST FILE FOR BANKRUPTCY?

Sort of. As a U.S. territory, the island cannot follow the court process used by other U.S. municipal governments such as Detroit. Gov. Ricardo Rossello triggered a bankruptcy-like process by declaring Puerto Rico could not agree to big cuts in spending and new taxes demanded by bondholders. His move puts in the hands of federal judge the restructuring of a portion of the island’s $73 billion in public debt. Puerto Rico was authorized to take this legal route under a restructuring plan adopted by Congress last year.

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WHY DID PUERTO RICO TAKE THIS STEP?

Puerto Rico has been negotiating with creditors, mostly investors who bought distressed Puerto Rican bonds at a discount in the hope of making a profit by demanding full payment or something close to it. Island officials have been working with a federal control board set up under the restructuring law adopted last year. The governor issued a 10-year spending plan that earmarked $800 million a year to pay interest and principal on bond debt, a fraction of the $35 billion due in such payments over the next decade. It would also make substantial cuts to public employee benefits and raise fees for services for the 3.4 million people living on the island. Bondholders wanted higher payments and steeper cuts. Negotiations broke down in recent days and creditors filed multiple lawsuits seeking to recover their money when a freeze on litigation expired this week.

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HOW DID ALL THIS HAPPEN?

Puerto Rico’s economy has been in recession for roughly 10 years. Manufacturing jobs started leaving after some federal tax credits expired, and the global economic slump that started in 2007 compounded the impact. The government borrowed heavily to cover budget shortfalls, leaving it with debt levels so large it is unable to pay its debts and struggles to provide basic public services. Puerto Rico bonds are exempt from federal and state income taxes for residents of all 50 states, which made them easy to sell to investors and enabled the territory to borrow so much for so long. Roughly a third of Puerto Rican tax revenue now goes to cover debt, and the territory also has more than $40 billion in unfunded pension liabilities. The island’s previous government declared the debt unpayable and the territory began a series of multimillion-dollar defaults in August 2015, which prompted Congress to pass the restructuring law last year.

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WHAT HAPPENS NEXT?

Some bondholders are expected to file legal challenges to Rossello’s decision but cannot do so for 120 days. The chief justice of the U.S. Supreme Court is expected to appoint a judge to oversee Puerto Rico’s case, the largest of its kind in U.S. history. The judge will be in charge of coming up with an orderly restructuring plan. Meanwhile, Puerto Rico must continue looking for ways to get its economy growing again.

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