Related Link Mystery: Strom Thurmond, Puerto Rico and bankruptcy protection

The U.S. federal government should consider paying Puerto Rico’s $70+ billion dollar debt in exchange for Puerto Rican statehood because Hamilton says so. Not Hamilton as played by Puerto Rican Lin-Manuel Miranda in the hit Broadway musical “Hamilton,” who only wants Puerto Rico to be allowed to file for bankruptcy, but the actual Alexander Hamilton.

One of Hamilton’s greatest achievements as the nation’s first Secretary of the Treasury was the federal government’s “assumption” of debts that state governments incurred winning the American Revolution. Hamilton thought the federal bailout of the states justified for a number of reasons, none of which really apply to the Puerto Rican case. That, however, doesn’t settle the matter because two states, Rhode Island and North Carolina, did not ratify the Constitution until after Hamilton made clear that their debts would be assumed by the federal government.

North Carolina joined the new nation at the end of November 1789 and Rhode Island at the end of May 1790 after receiving assurances that certain Constitutional amendments would be solemnly considered. In fact, by joining the Union, each state was able to help the Bill of Rights, the first ten amendments to the United States, to become part of the Constitution in December 1790. Ratification of the Bill of Rights was not certain when they joined the Union, however, and indeed a few of the amendments those states sought were never seriously considered. (And one was ratified over a century later!)

What North Carolinians and Rhode Islanders certainly understood when they voted to join the Union was that Hamilton, who became Treasury Secretary in September 1789, was hellbent on funding the national debt, including the debts of the several states. The exact payday for each state was unknown but certainly positive. When the Funding Act passed in August 1790, Rhode Island was allotted $200,000 and North Carolina $2.4 million, or approximately $2.85 and $6.25 per capita, respectively. That is peanuts today but a nice sweetener then, both for state taxpayers and for holders of state bonds. The latter received a “haircut” (reduction of principal) but were able to exchange state bonds of limited liquidity and shaky security for much more marketable and valuable federal securities.

Thereafter, the government made clear that states should not expect federal bailouts because of the well-known moral hazard problem. When states like Indiana and Mississippi ran up large debts in the 1830s that they could not repay in the 1840s, for example, the federal government refused to aid them. Such a policy was necessary lest the states effectively control the federal budget.

The policy of offering statehood to new territories only after they made adequate arrangements for the funding of their territorial debts was also salubrious because most territories really wanted, and needed, to join the Union. When the Dakota Territory was split into North and South Dakota, for example, the new states divided the territorial debt and paid it off through the issue of state bonds backed by specific sources of state revenue, a concession that citizens of each state believed was well worth the cost of two voting U.S. Senators.

Telling exceptions, however, reveal that statehood was subject to negotiation, not hard and fast rules.

When the United States annexed Texas in 1845, it allowed the Lone Star State to keep all of its public land if it sold it to pay off the considerable debts it had incurred winning its independence from Mexico. That decision gave Texas a huge, if rather illiquid, bonus for joining the Union. That creditors saw it as quite a concession is evidenced by the rapid rise in the prices of beaten down Texas securities until the new state, in its finite wisdom, began to scale back creditor claims and misallocate its revenues. As the great mid-19th century fiscal wit William Gouge explained, “some of the politicians of Texas seem to think that the United States have been annexed to Texas and not Texas to the United States.” The brazen politicians on the Brazos may have had a point because in 1855 the U.S. federal government settled with holders of Texas bonds for $7.75 million. As in the 1790 assumption of state debts, that imposed a haircut on bondholders but they acquiesced because federal bonds were far more valuable investments than the bonds of an unstable republic.

When it annexed Hawaii (albeit as a territory) in 1898, the U.S. federal government again assumed sovereign debt as part of the deal. As Richard Burdekin of Claremont McKenna College and others have shown, bondholders, this time mostly British, again benefited from increased bond prices.

Texas and Hawaii had more bargaining power than, say, the Dakotas, and before annexation the fiscal policies of Texas and Hawaii had not been closely controlled from Washington. Puerto Rico, too, has some bargaining power and obviously Washington has neglected to control its fiscal policies as effectively as it controlled those of its continental cousins and in that sense is partly to blame for the island’s woes.

So, clearly, there is ample precedent for the federal government to purchase Puerto Rico’s statehood by assuming its debts. But should it?

The question of Puerto Rico’s status has festered for too long. Some wish it to be independent and in the early 1950s nationalists engaged in deadly uprisings and presidential assassination attempts. In 1954, four Puerto Rican nationalists even shot up the U.S. House of Representatives. Today, however, it seems unlikely that statehood would foment much violence.

Others want Puerto Rico to become a state because it would be true “blue,” at least until in-migration makes it just another Sunbelt swing state in a generation or so. Of course the prospect of large-scale demographic and cultural change prevents many Puerto Ricans from embracing statehood as strongly as they otherwise might.

For those and other reasons, the status quo remains the path of least political resistance as it has been for decades. No Hamiltonian statesman interested in the commonweal, however, would want Puerto Rico to remain what the government has long made it, essentially an offshore Hispanic quasi-reservation where many businesses, retirees, and tourists fear to tread because of legal ambiguities and cultural and linguistic differences.

It is time to decide Puerto Rico’s status once and for all. If it becomes independent, it can claim bankruptcy like any other sovereign, renegotiate its debts, and make its own way in the world. If it becomes a state, the U.S. government can well afford to “assume” its debts and allow it to start over with a clean slate, just like those other tiny island states (one an island in name only) once did.

As a state unburdened from debt and doubt, Puerto Rico soon would cease to be a ward of the federal government as it blossoms economically, just as other former Spanish dominions, like Texas, California, and Florida, did after statehood. Yes, vulture capitalists will benefit from assumption, too, perhaps with a bit of a trim. But that is their just due, just as Hamilton argued two and a quarter centuries ago.