Puerto Rico and its various public corporations are saddled with debts that the island's governor, Alejandro García Padilla, says are "not payable" and lock them into a "death spiral" from which only some form of non-payment can allow them to escape.
The crisis originates in some of the many special rules that apply to the island. One makes bonds sold by Puerto Rico and its sub-units exempt from state, local, and federal taxation. That helped Puerto Rico borrow a lot of money in the 1990s and 2000s. But in 2006, Puerto Rico lost a different tax preference that subsidized its manufacturing, and it entered a recession. Then the Great Recession of 2008 hurt Puerto Rican tourism.
Those recessions started to make it difficult for Puerto Rico to pay the interest on its old loans. It needed higher taxes and cutbacks in government services to make it work.
The austerity budgets further damaged the Puerto Rican economy and encouraged Puerto Ricans to migrate to the mainland United States. Consequently, Puerto Rico's population has been steadily falling for years. Each person who leaves increases the amount of debt that each remaining person has to pay. And the tighter each Puerto Rican is squeezed by debt service payments, the more the economy suffers and emigration is encouraged.
And it gets worse. Puerto Rico, like a US state, has no legal mechanism to file for bankruptcy. But unlike a US state, there is also no legal mechanism for Puerto Rican towns, utilities, and other government entities to declare bankruptcy. Puerto Rico's governor says the debts can't be fully repaid and need to be restructured to give the island's economy a chance to recover, but he has no legal power to make that happen. If Puerto Rico doesn't pay what it owes, its creditors can sue and get federal courts to order bondholders be paid ahead of police, firefighters, pensioners, and other public services.
Hillary Clinton, Jeb Bush, and Martin O'Malley have all come out in favor of changing the bankruptcy code to let Puerto Rican municipalities file for Chapter 9 bankruptcy, but congressional Republicans deem this a "bailout" and won't agree.
Meanwhile, with or without debt relief, Puerto Rico desperately needs a return to economic growth. But many aspects of federal policy disadvantage the island. Medicare and Medicaid reimbursement rates are lower than on the mainland, which encourages doctors to emigrate. But the federal minimum wage applies, even though Puerto Rico is much poorer than the mainland. A federal shipping regulation called the Jones Act makes Puerto Rico's cost of living higher than that of similar islands, and federal welfare programs are not well designed for Puerto Rican conditions. Only Congress can fix this set of problems, but Puerto Rico isn't represented in the US Congress. And with some form of default looking likely, hedge funds that specialized in distressed debt are buying the island's bonds — and their interests certainly are represented on Capitol Hill.