Wednesday, January 22, 2014

Greece in the Carribean- Puerto Rico Moves Closer to Defaulting on $70 Billion in Public Sector Debt

News out of Puerto Rico so disturbing that I thought I'd lead with a picture of basketball wife Evelyn Lozada at the 2012 Puerto Rico Day Parade in New York City to take the edge off.

Remember that whole 'Cyprus' or 'Greece' thing? Years of unsustainable public-sector spending coupled with lower than expected economic growth plunged both Mediterranean countries into economic chaos that threatened to trigger a domino effect throughout the Eurozone beginning in 2010.

The same factors that led up to the Greek and Cypriot economic crises have been at work in the Commonwealth of Puerto Rico and analysts say that the Caribbean island and US territory is moving towards a near certain default on more than $100 billion is public sector debt and unfunded pension liabilities.

A possible suspension on payment of the debt comes despite the progress Puerto Rico's Gov. Alejandro Garcia Padilla has made in raising taxes and reducing the territory's deficit.

Any such decision partly reflects legal complications arising under Puerto Rico's ambivalent status, which today makes a Chapter 9 filing for bankruptcy protection for local governments, such as the Detroit municipal filing last July, impossible. It also reflects the maths of a debt service burden that requires paying between $3.4 billion and $3.8 billion each year for the next four years. As doubts grow about the ability of the commonwealth to service that debt, the cost of doing so will inevitably rise.

"The numbers are untenable," said one restructuring adviser. "To issue new debt the yield would have to rise and where they can't raise new money they will have to stop paying."

If Puerto Rico is forced to take that step, the effects will ripple through the entire $4tn municipal bond market. Because the debt is generally triple tax free, in a world of zero interest rates demand is high and it is distributed widely, including in funds that imply they have no exposure to Puerto Rico.

Puerto Rico cannot really raise taxes much more, since the debt per capita is more than $14,000, while income per capita is almost $17,000, a ratio at 83 percent—that makes California, Illinois or New York—each at 6 percent—models of prudence. Meanwhile, at 14 percent, the unemployment rate is twice the national average.

While Congress could theoretically intervene and create an insolvency regime for the island [similar, in theory, to Detroit's city emergency manager- NANESB!] the current partisan divide in Congress would lead to considerable wrangling with the GOP likely prioritizing the island needing to uphold their financial obligations to creditors versus the Democrats giving priority to the pensions of unionized public sector employees on the island.

Municipal and general obligation bonds from Puerto Rico have enjoyed what's called 'triple tax free' status [i.e. they're exempt from federal, state and local taxes- NANESB!] and have proven attractive to investors, but starting last year ratings agencies have cut much of the bonds' credit ratings to one notch above junk in light of recent developments.

Adding to the island's troubles is the considerable outmigration that began back in 2000- well before the 2008 global economic crisis. Some estimates say the net population loss since 2000 is in the neighborhood of 144,000- many of them younger people going to school or looking for work in the United States.

In what is perhaps the surest sign that US taxpayers will be on the hook for the ongoing situation on Puerto Rico, the White house stated that they were not considering a bailout of Puerto Rico on Wednesday.

Public opinion in Puerto Rico in recent decades has swung from full independence from the USA to status quo to support for becoming the 51st state.

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