A Politician Made Disaster In Need Of Structural Reform
Puerto Rico is a politician-made disaster area. It has more than $72 billion of debt, an estimated $30 billion shortfall in its state pension fund, two government agencies have already defaulted on debts, and it faces a $2 billion payment on July 1st.
How did the situation get this?
Like most governments that spend more than they collect, Puerto Rico issued bonds to cover budgetary shortfalls, and due to the favorable tax status that exempted these bonds from federal, state, and local taxes in all 50 states there was a hefty demand from the investment community. That changed in 1996 when Congress brought and end to favorable tax breaks for U.S. manufacturers operating in Puerto Rico. With a key inducement for those companies no longer in place, they closed down their operations and as any junior economist can tell you the resulting economic slump was written on the walls.
Change is difficult and in this situation, Puerto Rico doubled down on government stimulus spending which it had been following, which led to a doubling of its debt over the ensuing years and putting the islands on economic death watch.
At times such as this when all appears dire, emotions run high and finger pointing becomes the game of the day. Companies like monoline insurance providers, that guarantee to issuers, often in the form of credit wraps that enhance the credit of the issuer, have supported Puerto Rico for decades. In many ways companies like Ambac Financial Group AMBC -0.25% have been critical to Puerto Rico’s ability to access the capital markets and obtain low cost financing to fund its government and build its critical infrastructure. Approximately 20% of Puerto Rico’s municipal bonds are guaranteed by monoline insurance companies, including Assured Guaranty , MBIA MBI +0.93%, Ambac, FGIC and Syncora Holdings (SYCRF).
On its own, Ambac insures more than $2.0 billion of municipal bonds issued by the government of Puerto Rico. The company’s biggest exposure is to COFINA sales tax bonds, which don’t pay principal or interest until 2047-2054. By the time these bonds mature, Ambac will likely become the government’s largest creditor.
No matter the political party, the one-thing politicians all agree on is that someone else created the mess they are in. Some have declared verbal warfare against lenders, banks and hedge funds that have done work on the islands for decades. They have gone from saviors that built infrastructure to bandits and vultures. Of course, it isn’t the lenders fault and now rather than cut spending, reform welfare and taxes, create economic opportunity; the islands leaders want to declare bankruptcy.
Puerto Rico’s cries for bankruptcy are similar to the bankruptcy the city of Detroit filed for in July 2013. In many ways, Puerto Rico filing for bankruptcy would make the situation even worse in the short to medium-time given the high probability of reduced investor and consumer confidence, subsequent loss of economic growth likely sharp increase in borrowing rates.
Despite the claims of the Governor and his bankruptcy advisors, to say that Puerto Rico is over levered implies the US is as well. Including federal, state and local debt and unfunded pension and OPEB liabilities, Puerto Rico’s total debt to GDP is 98%, “substantially below the states’ median of 120%.” As the only tax haven within the US, Puerto Rico’s total tax collections to GDP is 11%, roughly half that of the US. Unfortunately, it appears the government of Puerto Rico has failed to reduce its expenditures and do everything it can in order to honor its financial obligations.
If not bankruptcy, then what should be done?
For the benefit of creditors and residents, Puerto Rico needs a responsible solution that is comprehensive and puts it on the path to sustainability. A responsible solution is one in which the government honors its financial obligations and implements meaningful fiscal reforms in order to strengthen its fiscal position and restore access to the capital markets. In addition, the government must implement meaningful structural reforms in order to encourage private investment, create jobs and grow the economy.
As part of these structural reforms, the government should implement a meaningful privatization program in order to reduce the size of the government and shrink the government’s debt load. Such a privatization program would increase private investment, create jobs and grow the economy. The government should also accept the creation of a financial control board to get their finances in order. Such a board has worked in the past for cities like Washington, DC and will work again for San Juan. All the politicians have to do is accept responsibility and get out of the way.
A Politician Made Disaster In Need Of Structural Reform
How did the situation get this?
Like most governments that spend more than they collect, Puerto Rico issued bonds to cover budgetary shortfalls, and due to the favorable tax status that exempted these bonds from federal, state, and local taxes in all 50 states there was a hefty demand from the investment community. That changed in 1996 when Congress brought and end to favorable tax breaks for U.S. manufacturers operating in Puerto Rico. With a key inducement for those companies no longer in place, they closed down their operations and as any junior economist can tell you the resulting economic slump was written on the walls.
Change is difficult and in this situation, Puerto Rico doubled down on government stimulus spending which it had been following, which led to a doubling of its debt over the ensuing years and putting the islands on economic death watch.
At times such as this when all appears dire, emotions run high and finger pointing becomes the game of the day. Companies like monoline insurance providers, that guarantee to issuers, often in the form of credit wraps that enhance the credit of the issuer, have supported Puerto Rico for decades. In many ways companies like Ambac Financial Group AMBC -0.25% have been critical to Puerto Rico’s ability to access the capital markets and obtain low cost financing to fund its government and build its critical infrastructure. Approximately 20% of Puerto Rico’s municipal bonds are guaranteed by monoline insurance companies, including Assured Guaranty , MBIA MBI +0.93%, Ambac, FGIC and Syncora Holdings (SYCRF).
No matter the political party, the one-thing politicians all agree on is that someone else created the mess they are in. Some have declared verbal warfare against lenders, banks and hedge funds that have done work on the islands for decades. They have gone from saviors that built infrastructure to bandits and vultures. Of course, it isn’t the lenders fault and now rather than cut spending, reform welfare and taxes, create economic opportunity; the islands leaders want to declare bankruptcy.
Puerto Rico’s cries for bankruptcy are similar to the bankruptcy the city of Detroit filed for in July 2013. In many ways, Puerto Rico filing for bankruptcy would make the situation even worse in the short to medium-time given the high probability of reduced investor and consumer confidence, subsequent loss of economic growth likely sharp increase in borrowing rates.
Despite the claims of the Governor and his bankruptcy advisors, to say that Puerto Rico is over levered implies the US is as well. Including federal, state and local debt and unfunded pension and OPEB liabilities, Puerto Rico’s total debt to GDP is 98%, “substantially below the states’ median of 120%.” As the only tax haven within the US, Puerto Rico’s total tax collections to GDP is 11%, roughly half that of the US. Unfortunately, it appears the government of Puerto Rico has failed to reduce its expenditures and do everything it can in order to honor its financial obligations.
If not bankruptcy, then what should be done?
For the benefit of creditors and residents, Puerto Rico needs a responsible solution that is comprehensive and puts it on the path to sustainability. A responsible solution is one in which the government honors its financial obligations and implements meaningful fiscal reforms in order to strengthen its fiscal position and restore access to the capital markets. In addition, the government must implement meaningful structural reforms in order to encourage private investment, create jobs and grow the economy.
As part of these structural reforms, the government should implement a meaningful privatization program in order to reduce the size of the government and shrink the government’s debt load. Such a privatization program would increase private investment, create jobs and grow the economy. The government should also accept the creation of a financial control board to get their finances in order. Such a board has worked in the past for cities like Washington, DC and will work again for San Juan. All the politicians have to do is accept responsibility and get out of the way.
A Politician Made Disaster In Need Of Structural Reform
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