Puerto Rico Defaults

The problem with something as big as our global economy is that it’s easy to get distracted. For example, as the world marveled over the Brexit, the market crash that immediately followed and subsequent stock market “recovery,” other major financial events went unnoticed. It’s fairly safe to assume that any major financial institution that has something to hide used the wall- to-wall Brexit coverage to avoid media scrutiny.

One those events buried by the Brexit headlines was that Puerto Rico, not quite a U.S. state but still pretty close, defaulted on most of an $800 million dollar payment on general obligation bonds. Puerto Rico has been teetering on the edge of default for some time but those bonds, backed by the territory’s constitution, are supposed to get paid before any other expense. The Puerto Rican government decided that paying police, firefighters and school teachers was more important and defaulted on the payment. The territory claims to only have $350 million available to pay its bills.

How Did We Get Here?

Puerto Rico’s economy has been in recession for more than a decade. When tax incentives meant to lure manufacturing to the island territory expired, most companies just packed up and left. Piling on top of that was the 2007-2009 Great Recession. The territory has a reputation of being a tax haven and once the manufacturing jobs left Puerto Rico found it had no other revenue sources. The territory’s unemployment rate hovers around twelve percent, more than double the rate of the U.S. mainland.

Historic Default

No other state or territory has defaulted on a general obligation bond since 1933, in the wake of the Great Depression. The math is fairly devastating; with Puerto Rico over $70 billion in debt, more than $20,000 for every man, woman and child, the island is starting to look like Greece in many ways. Both nations illustrate how a lack of tax base and infrastructure investment leads to the “zombification” of a country. Greece has shown zero growth since 2006 and continues to struggle to make loan payments. Creditors have already taken a write-down on Greece’s bonds and the IMF says more losses are ahead. Not a great example for our island territory.

Enter the Bailout

Actually, both Congress and the White House are scrupulously avoiding the term “bailout” when it comes to negotiating the restructuring of Puerto Rico’s debt. The compromise legislation, signed just last Thursday by President Obama, calls for the formation of an oversight committee to restructure the island territory’s debt. Since Puerto Rico is not technically a state it does not have access to state bankruptcy protection, like Detroit. The ink was barely dry on the legislation when Puerto Rico announced they wouldn’t be making the July 1 payment. Normally defaulting on general obligation bonds would immediately trigger a lawsuit, but the legislation stays any pending litigation.

This is What Deflation Looks Like

Americans should take a good, hard look at Puerto Rico and Greece because that’s what deflation looks like. Real estate prices crater, unemployment increases and the economy becomes the walking dead. In that state an economy can continue to limp along but it can’t grow. Unless an economy becomes so sick that the creative destruction of capitalism can wipe it out and build anew on a stronger foundation, the old economy just keeps hanging on. Greece is a perfect illustration of how an economy can continue to exist in a dreadful, barely alive state and it looks like Puerto Rico will be next.

Two Options, Neither Good

So of course, option one for Puerto Rico is a government bailout.  While that would certainly cause a lot of U.S. taxpayer grumbling, it would allow the troubled island to limp along for a while longer.

The social Darwinist option is a more Draconian, and goes a little bit like this: Sometimes it’s necessary for investors, who seldom read the prospectus, to lose money. Sometimes even institutional investors, like pension funds, need to be allowed to lose all their money.  So, not a great set of options – we pay or seniors, who had no control over where their pension funds are invested, and Puerto Rican families, starve.

Don’t you wish you had Brexit back?