So bankrupt there is no way they could pay it back.
Anyone investing in bonds associated with Puerto Rico will be lucky to get back 5 cents on the dollar.
If you have bond instruments in any blue state I recommend you keep a close on the financial solvency situations in those states.
All told, Puerto Rico owes close to $123 billion in total liabilities, according to The New York Times, including $73 billion in bonded indebtedness and $50 billion in unfunded pension liabilities.
Let’s be clear here: Puerto Rico, with just 3.5 million in population, will never be able to pay back that sum. As the Times reminds us, this is the “largest government to seek refuge from its creditors in United States history.”
Bondholders who bought Puerto Rican bonds are about to get a major haircut on their holdings.
While we are always sympathetic with those who lose money in markets, it’s hard not to fault bondholders who thought a government could never go bankrupt — or, in this case, the equivalent of bankruptcy.
Last year, Congress’ “Promesa” bill gave Puerto Rico more options for renegotiating its debts, while a seven-member board named by Congress helped manage the island’s finances.
Now, with talks at an impasse, Puerto Rico is making use of the only weapon it has: the federal courts.
We’ve seen this before, so it’s surprising that bondholders didn’t see this coming.
Were any of them alive during the 1980s? Then, country after country in Latin America renounced their debts and banks wrote off massive amounts, one of the few dark clouds of the 1980s boom. To make sure that a debt renunciation ripple effect didn’t turn into a tidal wave, the U.S. Treasury got involved, issuing U.S. bonds that were used to back up Latin American nations’ shaky debts.
Puerto Rico’s followed the same path with the same results.
Bad policies based on government promises of lavish welfare benefits and spending on questionable projects created a mountain of debt. Local work rules made it prohibitively expensive to hire local workers.
Meanwhile, foolish policies imposed on Puerto Rico by Congress have damaged the economy. These include the U.S. minimum wage, the anti-competitive Jones Shipping Act that raises the cost of living for Puerto Rico without any offsetting benefits, and the phasing out of manufacturing subsidies have all contributed to the economy’s tragic decline.
This has led to a massive population exodus, as young Puerto Ricans move to the U.S. seeking better lives, leading to an ongoing and devastating shrinkage in Puerto Rico’s economy. It couldn’t pay its debts now if it wanted to.
In the last decade or so, the U.S. commonwealth of 3.5 million has lost 10% of its population, according to an IMF study last year. Official unemployment is 12%, but in reality much higher, since only 40% of the adult population is either employed or looking for a job.
As we noted last year, the Puerto Rican welfare state has destroyed its workforce. A household of three in 2016 could get to $1,743 a month in food stamps, AFDC, Medicaid and utilities subsidies. Meanwhile, even if you earn the minimum wage, you’ll earn about $1,159. Someone earning the minimum wage takes home $1,159. People are being paid not to work.
Now, with Puerto Rico’s precedent, troubled U.S. states will no doubt avail themselves of the federal bankruptcy court system to receive whatever kind of relief that Puerto Rico gets. With U.S. states facing more than $1 trillion in unfunded pension liabilities, it could get very ugly.
Unfortunately, both states and their bond investors likely will forget the real lesson here: Governments have to live within their means. Making extravagant promises based on an ever-expanding welfare state is a surefire route to bankruptcy.
And, yes, the laws of economics prevail for governments as well as for individuals. States can’t run up their debts and trash their economies, and not expect a day of reckoning. Here, economist Herb Stein’s dictum is directly relevant: “If something can’t continue, it won’t.” That should be a sign on every bond investor’s desk.