The governor of Puerto Rico has decided that the island cannot pay back its more than US$70 billion (NZ$102b) in debt, setting up an unprecedented financial crisis that could rock the municipal bond market and lead to higher borrowing costs for governments across the United States.
Puerto Rico’s move could roil financial markets already dealing with the turmoil of the renewed debt crisis in Greece. It also raises questions about the once-staid municipal bond market, which states and cities count on to pay upfront costs for public improvements such as roads, parks and hospitals.
For many years, those bonds were considered safe investments – but those assumptions have been shifting in recent years as a small but steady string of US municipalities, including Detroit, as well as Stockton and Vallejo in California, have tumbled into bankruptcy.
Those defaults at least offered investors the protection provided by Chapter 9 of the US bankruptcy code, which sets out an orderly process by which investors can recoup at least some of their money. But like states, Puerto Rico is not permitted to file for bankruptcy. A failure to iron out an agreement with creditors could ignite an unwieldy, uncharted and long-lasting process to sort out the island’s financial obligations.
In addition, with as much as $73 billion (NZ$106b) in debt, the island’s debt obligation is four times that of Detroit, which became the largest US city to file for bankruptcy in 2012.
The implications are serious for Americans outside Puerto Rico largely because many hold island bonds in mutual funds. At one point in 2013, an estimated three out of four municipal bond mutual funds held Puerto Rican bonds, which were attractive because of their high yields and exemption from federal, state and local taxes.
Puerto Rico’s governor, Alejandro Garcia Padilla, will seek concessions from creditors, which range from mutual funds in the United States to large hedge funds that have been buying Puerto Rican debt at high interest rates, in an effort to stretch out loan payments and drive down borrowing costs that are hamstringing Puerto Rico’s struggling economy.
The government’s conclusion that it is unable to pay its debts was first reported by the New York Times. “It’s accurate,” said Gabriela Melendez, a Washington-based spokeswoman for the Puerto Rican government. She said the governor was scheduled to make a televised address updating islanders about Puerto Rico’s fiscal crisis on Monday evening.
A US commonwealth with a population of 3.6 million, Puerto Rico carries more debt per capita than any state in the country. The island has been staggering under the increasing weight of those obligations for years as its economy has tanked, triggering an exodus of island residents to the mainland not seen since the 1950s.
Meanwhile, the government has raised taxes, cut government employment and slashed pensions in a futile effort to get its debt burden under control. Those actions have only slowed the acceleration of debt creation, while harming efforts to reignite the economy.
The financial crisis in Puerto Rico has been playing out for years, although until now the government has been able to keep things moving by cutting spending and borrowing more and more money on Wall Street. But with rating agencies downgrading Puerto Rican debt to near-junk levels, the island has had to pay high rates to borrow money.
The island’s web of debt includes general-obligation bonds, which Puerto Rico’s constitution says must be repaid even before government workers receive their pay.
But billions of dollars more in bonds were floated by public corporations that provide critical services on the island, including providing electric power, building roads and running water and sewer authorities. Beyond the bond debt, the island owes some US$37 billion (NZ$53.9b) in pension obligations to workers and former workers.
CRITICAL IMF REPORT
Puerto Rico needs to restructure its debts and should make reforms including cutting the number of teachers and raising property taxes, a report by former International Monetary Fund economists on the Caribbean island’s financial woes said.
The report, which was obtained by Reuters, gave a damning review of how Puerto Rico has arrived at its current state, which it said requires both structural reform and debt restructuring to fix.
“Puerto Rico faces hard times,” the report said. “Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt… A crisis looms.”
The report even suggests the restructuring of general obligation debt, which could be a precedent-setting move as investors usually regard as sacrosanct.
Social reforms proposed include suspending the minimum wage and reducing electricity and transport costs. The island must overcome a legacy of weak budget execution and opaque data, the report said.
The report was written by former IMF economists, who were engaged in February by the Government Development Bank to analyse the island’s economic and financial stability and growth prospects.
The document, first posted on Puerto Rico media websites, was verified as authentic by one of the authors.
– The Washington Post / Reuters