Published on:

What You Need to Know About Puerto Rico’s Debt Crisis

By

Puerto RicoIn May 2017 the US territory of Puerto Rico, a small commonwealth of about 3.5 million people, filed for bankruptcy-like protections to address its crippling debt crisis, which encompasses more than $120 million in municipal bonds and unfunded pensions. The island owes about $34,000 for every resident, and its population is preparing for strict austerity measures—including the slashing of budgets for public services, such as schools—as they deal with the fallout of two devastating hurricanes. US District Court Judge Laura Taylor Swain, of the Southern District of New York, is now overseeing a federal oversight board working to negotiate with creditors and ease the territory’s debts. Here’s what you need to know about how the crisis emerged and how it affects your investments.

For most of the 1900s, Puerto Rico was governed by tax laws that were generally more favorable to businesses than the rest of the US, attracting many companies to the territories. Those laws ended in 2006, causing many companies to leave the island, consequently causing Puerto Rico to experience tax shortfalls. The territory’s government addressed these shortfalls by issuing a large number of municipal bonds. For most of the 1900s, Puerto Rico was governed by tax laws that were generally more favorable to businesses than the rest of the US, attracting many companies to the territories. Those laws ended in 2006, causing many companies to leave the island, consequently causing Puerto Rico to experience tax shortfalls. The territory’s government addressed these shortfalls by issuing a large number of municipal bonds, whose underwriters, including Santander Bank, UBS, and Citigroup, employed questionable underwriting practices. And even as the company’s economy worsened, bondholders continued extending its credit. And as the debt grew in size, it grew in complexity as well, as the New York Times notes, “with some branches of government issuing bonds on behalf of others, or backstopping each other’s debts, until it became nearly impossible to keep track of it all.” Still, demand for the bonds remained high, because their interest was tax-exempt, and investors had the comfort of knowing states and territories cannot file for bankruptcy—at least, until Congress passed a law in 2016 allowing Puerto Rico to file for certain protections.

As the crisis grew, large numbers of Puerto Ricans left the island. It suffered a population loss of approximately 10% over the last ten years, which meant a decreased in tax revenues. These factors led Puerto Rico’s debt eventually grew to such a point that the government could not pay interest on the bonds. It doesn’t help that the island is governed by a sprawling bureaucracy. Its treasury department has reportedly failed to efficiently collect tax revenue and the government’s accounting and fiscal oversight systems suffer from defective processes. More than half of the population are on Medicaid or Medicare, but the island receives much less funding from the federal government for these programs than US states, compounding the island’s poverty as underpaid health care professionals leave Puerto Rico for the continental US. The government has compensated for its underfunded system by, among other measures, borrowing more money. Its debt has also rendered the territory unable to make promised pension payments, placing pensioners at risk of substantial cuts.

What can be done? After Puerto Rico filed for bankruptcy-like protection in May, Moody’s Investor Service published a note that stated: “In the judicial debt restructuring process, a weaker economic outlook could support arguments in favor of lower bondholder recoveries… Limitations on the government’s capacity to operate electricity systems—as well as ports, water and sewer service and transportation infrastructure—will hurt rate, fee and tax collections while also impeding commerce.” In the wake of Hurricanes Maria and Irma, many have called for the cancellation of the island’s debts. This would cause significant losses for mutual and pension funds as well as individual investors; Puerto Rico has already been sued by various creditor groups, some of whom have also sued each other, and now it’s up to the Judge Swain to assess the various intersecting claims. Others have argued for austerity measures. Whether the United States government will listen to those calling for debt amnesty or even harsher fiscal policies remains to be seen.

By
Posted in:
Tagged:
Published on:
Updated:

Comments are closed.