The folks who lent money took risks. They made bad bets. They should lose their investments.

Loans were given with the knowledge that Bankruptcy law at Chapter 9 does not permit Puerto Rico, or any of its municipalities, to be a debtor under Chapter 9. Absent a change to the law, Puerto Rico should not be able to obtain any bankruptcy protection.

Bankruptcy Chapter 9, 109(c), Who May Be A Debtor,

http://law.justia.com/codes/us/2015/title-11/chapter-1/sec.-109/

(c) An entity may be a debtor under chapter 9 of this title if and only if such entity—

(1) is a municipality;

(2) is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter;

(3) is insolvent;

(4) desires to effect a plan to adjust such debts; and

(5)(A) has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

(B) has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

(C) is unable to negotiate with creditors because such negotiation is impracticable; or

(D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title.

I'm not suggesting bankruptcy protection. Simple default.

Without bankruptcy protection, would the debtors have to dissolve assets until creditors are paid or assets are all gone? The Puerto Rican government might find itself broke and homeless.

Without bankruptcy protection, would the debtors have to dissolve assets until creditors are paid or assets are all gone? The Puerto Rican government might find itself broke and homeless.

When dealing with a sovereign it becomes much trickier, however, for a variety of reasons, the biggest of which is practical.

Creditors cannot resort to self-help. Even in private transactions if the landlord barges into the apartment and takes things to pay a debt, or a repo man breaks into a house to take collateral, they are treated as criminals. Money may be owed, but to extract it requires the courts and the sheriffs.

And therein lies the rub. Sheriffs are paid by governors and mayors, not judges. Judges may issue orders that the police are "bound" to respect, but judges are nowhere in the chain of command of the actual officers. That chain of command ends at chief executives.

So, the chief executive might be held in contempt of court - but probably enjoys executive privilege against being jailed for it...and once again, to actually take possession of a man and jail him would require police officers - of the executive branch - to obey people who are not in their chain of command, over against the people in their chain of command who pay their paycheck.

Now, a despised chief executive probably can be arrested fairly easily, because his successor will rubber stamp the decision of the police. But a strong populist, with the people and political class at his back, probably cannot be.

And THEN what? Well, then you have people with a theoretical legal "right" to "repossess" thus and so, but who have no practical ability to do so because there is nobody to execute the order of repossession, and if they try self-help they will be shot by the police as burglars.

Individual creditors who lend to sovereigns do not have the same power over their debtor as they do when they lend to other individuals, because the sovereign will enforce the debts against individuals, but the sovereign ultimately CHOOSES to enforce the debt against itself, and if it chooses not to, there is no real recourse.

Obviously this would be a crisis situation, but as we have seen with recent Presidents, once they command people to do things that are objectively illegal, it is nevertheless virtually impossible to stop them or hold them accountable, because the Executive branch obeys the Chief Executive, and law enforcement is all part of the Executive Branch.

So, if the Governor decides to protect the standard of living of Puerto Ricans, by making fewer cuts than required (thereby extending repayment time to the lenders), it's an open question as to who obeys whom.

We know from the experience of sovereign debt default all over the world that there are always more people who want high yields who will take the risk. They always have, everywhere. Most get paid. Some get burned.

When dealing with a sovereign it becomes much trickier, however, for a variety of reasons, the biggest of which is practical.

The statement is true as stated, however, Puerto Rico is in no sense a sovereign. It is a possession. Its citizens are U.S. citizens, but they have no vote in Congress, and they cannot vote in Presidential elections. Puerto Rico is not one of the sovereign states and a member of the constitutional union. It is a possession of the United States. For the price of not being a state, they pay no Federal income tax.

Creditors cannot resort to self-help.

No, but lenders can resort to the courts. Normally, the debtor can resort to bankruptcy protection in court. However, Puerto Rico cannot resort to bankruptcy protection. Said Chapter 9 protection has been made to explicitly apply only to State municipalities, and neither Puerto Rico nor any of its cities or towns is a State municipality.

Individual creditors who lend to sovereigns do not have the same power over their debtor as they do when they lend to other individuals, because the sovereign will enforce the debts against individuals, but the sovereign ultimately CHOOSES to enforce the debt against itself, and if it chooses not to, there is no real recourse.

Again, while the initial claim is true, Puerto Rico is not a sovereign, and does not enjoy the sovereign power of a State. The creditors were not dealing with a sovereign, so this is an uncommon case. Not being a sovereign, Puerto Rico has no power to choose whether or not to enforce the debt against itself. The actual sovereign, the United States, ultimately must choose what to do if Puerto Rico chooses or is simply unable to pay its debts.

Puerto Rico is most like another class of debtors, people who have recently declared bankruptcy and have used bankruptcy protection against debtors. For some time afterwards, they are ineligible to invoke said protection again. But Puerto Rico is ineligible for Chapter 9 reorganization protection in the first place.

All bankruptcies are in Federal Bankruptcy courts. 28 U.S.C. § 151

If Puerto Rico fails, the Federal government can impose direct rule and do as it pleases with the assets of the municipal government. The municipal corporation has continued to spend with reckless abandon while it has no hope of paying its ever expanding debt. A Federal bailout of Puerto Rico may be at the expense of dissolution of the municipal corporation.

I don't know what the Federal government actually will do, but Puerto Rico is powerless to absolve its own debts. What Puerto Rico will do seems to be an inevitable default on its debts. What the lenders will do seems to be an inevitable initiation of a bankruptcy proceeding against the municipal corporation of Puerto Rico in Federal court. Only the Congress can rewrite the law to extend Chapter 9 reorganization protection to Puerto Rico.

So, the chief executive might be held in contempt of court - but probably enjoys executive privilege against being jailed for it...and once again, to actually take possession of a man and jail him would require police officers - of the executive branch - to obey people who are not in their chain of command, over against the people in their chain of command who pay their paycheck.

Now, a despised chief executive probably can be arrested fairly easily, because his successor will rubber stamp the decision of the police. But a strong populist, with the people and political class at his back, probably cannot be.

It is not clear if you refer to the Chief Executive of Puerto Rico, or to the President of the United States. Nothing is happening to POTUS. The Federal government need not arrest the Governor of Puerto Rico. They can just reinstitute direct rule and dissolve the municipal corporation.

Neither the Executive, Judicial, nor Legislative Branch of Puerto Rico can authorize or print money. The Commonwealth cannot decide a bankruptcy case, and cannot absolve its debts. The municipal corporation of Puerto Rico can only sit and watch what is done to them if the Federal court decides.

Either the Federal Congress is going to do something, or the Federal Courts will be forced to resolve what is to be done about the debts. Normally, absent bankruptcy protection, they seize and auction the assets, and pay the lenders what can be paid. This case is definitely not normal. Neither is this Congress. And municipal corporation of Puerto Rico is far out there.

As they have chosen to avoid statehood and Federal income taxes, it is difficult to see any Federal obligation to bail them out.

39 Stat 951, An Act to Provide a civil government for Puerto Rico, and for other purposes (2 March 1917), HR 6333, PL 368

64 Stat 319, An Act to provide for the organization of a constitutional government by the people of Puerto Rico of 3 July 1950, S 3336, PL 600

The Federal government need not arrest the Governor of Puerto Rico. They can just reinstitute direct rule and dissolve the municipal corporation.

They could, yes, but it would require Congress to do did that. The Supreme Court itself doesn't have the authority to impose a political solution like that: reimposing direct rule, particularly not to satisfy the financial demands of private creditors.

Would Congress do it? The political perils are enormous in all directions. For one thing, if the Puerto Rican economy craters - as it will if the government is essentially liquidated to pay private debt - the result will be mass immigration to the United States, mainly Florida, which will tip that state decisively into the Democratic camp in the Electoral College.

It'll be settled by political compromise because it has to be.