A schoolteacher demonstrates outside of the Capitol building as the Lower House of Congress voted to approve modifications to the Teacher's Pension System in San Juan, December 21, 2013. Puerto Rico, with an economy in or near recession for the last eight years, has chronic budget shortfalls and has spawned worry among investors in the $3.7 trillion municipal debt market, where its bond prices have plunged this year. Picture taken December 21, 2013. REUTERS/Alvin Baez (PUERTO RICO - Tags: EDUCATION POLITICS BUSINESS EMPLOYMENT) - RTX16RDT (Reuters)
Amid a surfeit of debt and other downward-trending economic indicators, Puerto Rican legislators put it all on the line last week when it added an additional $3.5 billion worth of IOUs to its balance sheet. Island leadership can now only hope that the money raised will patch the economy long enough to allow newly enacted policies to turn it around ... if it turns around.
Unfortunately, the combination of poor economic trends, along with last week’s effort to finance short-term debt with long-term bond obligations, only solidifies my opinion of the inevitable: Puerto Rico will have no choice but to default.
Since Puerto Rico lacks the same judicial system recourse, it has to shed its fat by yanking off the fiscal Band-Aid and restructuring its debt.
Before I’m accused of being a doom-and-gloomer, bear in mind that a debt default may be just what the doctor ordered. The more than $1 billion deficit expected to round out the current fiscal year – in addition to a number of other short-term notes due – that justified selling junk-rated bonds to American investors are only the tip of Puerto Rico’s debt iceberg. Altogether, pensions, 401(k)s, bond funds, hedge funds, and individual investors held more than $72 billion in Puerto Rican bonds before last week, more than seven times Puerto Rico’s annual revenues. Add in another $40 billion in unfunded pension liabilities and total debt easily surpasses the 100 percent debt-to-GDP ratio that puts most lenders on edge.
Puerto Rico’s well-known dependency on credit first made public waves when every credit-rating agency gave Puerto Rico a vote of no confidence last month, citing major liquidity concerns as the biggest culprit for the downgrades. Although non-disclosure agreements prevent us from knowing precisely what turned these agencies off, there have been a few clues. In fact, Puerto Rico was so desperate for short-term funds at one point that it kept the change from a loan Uncle Sam extended to cover IRS tax credits. Regrettably, the U.S. Treasury Department hasn’t forgotten about that $350 million.
Statements released ahead of this latest bond offering make it clear that the $3 billion Puerto Rico borrowed from investors is expected to only temporarily mend liquidity concerns, and only if the government is able to balance the budget next year, a hefty feat that hasn’t been achieved in nearly a decade. Issues of liquidity, combined with few deep spending cuts, make it hard to take discussions of “balance” seriously.
Given the increased risk, Puerto Rico’s junk bonds required a rate-of-return comparable to many credit card companies. At nearly nine percent, the island is now on the hook for another $315,000,000 per year in interest alone. The last I checked, an additional $300,000,000 in debt puts Puerto Rico over the edge of its constitutionally-defined debt limit, which means it could have another major legal battle on its hands in the near future.
To ease lender concerns, legislators in Puerto Rico boast that revenues and employment have grown considerably from mid-2013 through February.
Although increased revenues seem like a much-needed glimmer of hope, the Debbie Downer in me has to point out that all of the growth comes from a resource with limited patience. Radical tax increases of 20 percent on high-income earners and 60 percent on corporations have given rise to a mass exodus and a recent economic downturn that will only get worse as employers are forced to cut back or pass costs on to consumers.
Trying to convince us that job opportunities aren’t as bad as the media portrays, the Governor of Puerto Rico insists that as many as 30,000 jobs have been created since 2013. The President tried to use the same “created or saved” tactical messaging with some success, but official statistics tell a different story. In the aggregate, more than 11,000 have become unemployed since January 2013, increasing the unemployment rate by more than a full percentage point.
With such poor employment prospects, can anyone blame the young professionals who are leaving Puerto Rico at a faster rate than anywhere else in the country? Much like with Obamacare, Puerto Rico’s future depends on their contributions and will fail without them.
While a major short-term loan might have helped stymie economic bleeding until growth policies have time to take effect, current policies are anything but. Policies that favor foreign investors, yet burden domestic ones discriminate against the ones who have the greatest long-term vested interest in Puerto Rico. Refusing to restructure public corporations that account for a third of total debt means average citizens and small businesses are overpaying for services they require just to keep their doors open. For example, restaurants are now paying more for electricity provided by the publicly-run electricity company than they pay for rent, on average. Only the most motivated and well-funded entrepreneurs have any chance in this climate.
Since legislators are showing little interest in changing their tax-and-overspend policies, and Puerto Rico can’t print itself more debt to cover their fiscal mismanagement, it now has no choice but to break the debt cycle, one way or another.
But debt “restructure” and “default” shouldn’t be the dirty words many would like us to think. In fact, the rest of the country has laws to allow for a formal, organized pathway for poorly-run organizations to reorganize, divest inefficient operations, and restructure debts through bankruptcy courts so that more efficient economic actors can have their turn. It makes us all better.
Since Puerto Rico lacks the same judicial system recourse, it has to shed its fat by yanking off the fiscal Band-Aid and restructuring its debt. Speculators will suffer the most, and may have the loudest complaints, but after the initial shock Puerto Rico will finally have the chance to break its cycle of deficit-spending and will only then have another opportunity to make the right decisions that ensure long-term economic prosperity.
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