http://www.zerohedge.com/news/2014-02-15/puerto-rico-%E2%80%93-america%E2%80%99s-version-greece
Submitted by Tyler Durden on 02/15/2014 18:00 -0500
Puerto Rico – America’s Version Of Greece?
Submitted by Pater Tenebrarum of Acting-Man blog,
The Crisis Worsens
We previously discussed Puerto Rico in these pages in October of last year (see “Puerto Rico’s Debt Crisis – Another Domino Keels Over”). At the time, the public debt crisis looked increasingly worrisome – in fact, it seemed as though Puerto Rico would eventually have to apply for a federal bail-out, and if it failed to get one, it might have to restructure its debt (it actually cannot do that, see further below). Several months have now passed and the situation apparently hasn't gotten better. Before we continue, allow us to point out though that noted contrarian Jeff Gundlach thinks that Puerto Rico will eventually be rescued – he believes that too many politicians have a vested interest in not letting anything bad happen:
“Municipal bonds are slightly overvalued, he said. Investors who are willing to tolerate volatility will get rewarded for the risk in Puerto Rico’s bonds. Too many politicians rely on votes tied to the stability of Puerto Rico to allow a crisis there, according to Gundlach. “Puerto Rico’s bonds are going to make it to the other side of the valley,” he said.”
(emphasis added)
We should point out to this that politicians don't always get what they want, especially in the event of a debt crisis. The cost of rescuing Puerto Rico may be deemed too high, and the politicians with a vested interest are not the only ones needed to green-light rescue measures. In the event of a bailout, others will have to justify their support to their own constituents. With that out of the way, here is a fairly recent chart of the Barclay's Puerto Rico municipal bond index:
Puerto Rico's bonds continue to plummet - click to enlarge.
S&P has just downgraded Puerto Rico's debt to junk, as reported here:
“The most recent blow to Puerto Rico’s economic reputation is yet another downgrade of its debt, this time to junk. S&P slashed the rating on Tuesday because, in a nutshell, the commonwealth is going to need a lot more money and that money isn’t going to get any easier to come by.Although some initial reports indicate that investors are shrugging off the downgrade, the possibility of further downgrades by the other two major ratings agencies, Moody’s and Fitch (which both currently rate Puerto Rico a mere notch above junk), could spark a sell-off by institutional debt holders. That would make it even more difficult for the government to raise the cash it sorely needs.”
(emphasis added)
There has of course already been a lot of institutional selling in Puerto Rico's debt, as the decline in its bond prices attests to. However, to the extent that the bonds are contained in investable indexes and other tracker products such as ETFs, future rating downgrades would of course provoke additional selling.
The economic backdrop meanwhile isn't particularly encouraging:
Puerto Rico's annual GDP growth – essentially the territory has been in a severe recession since 2007 – click to enlarge.
Total public debt since 2007. The public debt-to-GDP ratio is almost at 100% by now – click to enlarge.
On the Skids
According to a recent article in the NYT, Puerto Rico has a set of problems that reminds us a bit of Greece in several respects. Specifically, the persistence of the economic slump, the high unemployment rate, the incredible size of the public debtberg relative to the population, and an accelerating exodus of said population as it no longer sees a future for itself in the territory. The new governor has even jokingly wondered whether it was really such a good idea to take the job:
“Puerto Rico’s slow-motion economic crisis skidded to a new low last week when both Standard & Poor’s and Moody’s downgraded its debt to junk status, brushing aside a series of austerity measures taken by the new governor, including increasing taxes and rebalancing pensions. But that is only the latest in a sharp decline leading to widespread fears about Puerto Rico’s future.In the past eight years, Puerto Rico’s ticker tape of woes has stretched unabated: $70 billion in debt, a 15.4 percent unemployment rate, a soaring cost of living, pervasive crime, crumbling schools and a worrisome exodus of professionals and middle-class Puerto Ricans who have moved to places like Florida and Texas.The situation has grown so dire that this tropical island, known for its breathtaking beaches, salsero vibe and tax breaks, is now mentioned in the same breath as Detroit, with one significant difference. Puerto Rico, a United States territory of 3.6 million people that is treated in large part like a state, cannot declare bankruptcy.From bottom to top, Puerto Ricans are watching it unfold with a mixture of disbelief and stoicism. Alejandro García Padilla, who was elected Puerto Rico’s governor by a sliver of a margin in 2012, said that after he began to wade deeply into the island’s economic and social quagmire, his fight-or-flight instincts kicked into high gear.“I thought about asking for a recount,” Mr. García Padilla, 42, said with a grin during a recent interview in La Fortaleza, the 500-year-old government residence, recalling, among other things, the $2.2 billion deficit. “But now it’s too late.”
(emphasis added)
Puerto Rico cannot declare bankruptcy, but that doesn't actually matter. It can still go bankrupt anyway, with or without a 'declaration'. We're actually not sure what this is supposed to mean in practice. Does it mean that servicing its debt takes precedence over all other government expenditures? In that case one could envisage a hypothetical future in which the only remnant of its government will be a band of armed tax collectors.
Similar to Greece, the measures taken to lower the deficit have probably made the deficit ultimately worse by destroying large swathes of the small business sector:
“A sense of pessimism pervades on the island. Streets are lined with empty storefronts in San Juan and in smaller cities like Mayagüez;small businesses, hit hard by high electricity, water and tax bills and hurt by drops in sales, have closed and stayed closed.Schools sit shuttered either because of disrepair or because of a dwindling number of students. In this typically convivial capital, communities have erected gates and bars to help thwart carjackers and home invaders. Illegal drugs, including high-level narco-trafficking, are one of the few growth industries.”
(emphasis added)
Evidently, the government has taken the euro area approach to dealing with excessive government debt. This is to say, instead of concentrating on cutting its spending, it has raised the fiscal burden on businesses, many of which cannot continue to operate given the new impositions. This in turn lowers tax revenues, as many formerly tax paying establishments no longer exist. The predictable effect on the public debt is that it keeps growing.
Austerity always seems to mean 'austerity for everyone except government'. However, that is a formula that cannot possibly work, as it amounts to slaying the goose that lays the golden eggs. The result is a never-ending tale of woe:
“Puerto Rico, about 1,000 miles from Miami, has long been poor. Its per capita income is around $15,200, half that of Mississippi, the poorest state.Thirty-seven percent of all households receive food stamps; in Mississippi, the total is 22 percent.But the extended recession has hit the middle-class hardest of all, economists said. Jobs are still scarce, pension benefits for some are shrinking and budgets continue to tighten. Even many people with paychecks have chosen simply to parlay their United States citizenship into a new life on the mainland.Puerto Rico’s drop in population has far outpaced that of American states. In 2011 and 2012, the population fell by nearly 1 percent, according to census figures. From July 2012 to July 2013, it declined again by 1 percent, or about 36,000 people. That is more than seven times the drop in West Virginia, the state with the steepest population losses.”
(emphasis added)
The shrinking population is obviously a significant problem as well – it means that the burden of the government's debt is borne by fewer and fewer citizens, who must fear that even more hardship will be imposed on them. This in turn is likely to accelerate the exodus.
And indeed, the enormous costs businesses face in Puerto Rico are inter alia a direct result of government running major industries – running them into the ground, that is. Citing the example of a struggling small business owner the NYT writes:
“But his expenses mounted, including $600 a month in power bills, more than double what consumers pay on the mainland. The sky-high cost is a consequence of Puerto Rico’s inefficient government-run monopoly on electricity and its 67 percent dependency on petroleum for electric power. Other utilities are exorbitant, too. Last year, water rates rose 60 percent in a bid to help cut the state-run water company’s debt. “
(emphasis added)
Obviously letting the government run electricity and water utilities was a bad idea, as it always is. Such publicly-owned monopoly industries usually provide ample opportunities for graft and political cronyism (see Greece as a pertinent example) and it was probably no different in Puerto Rico. Here are a few of the things the new governor has done to bring the deficit down:
“Vowing not to lay off any more workers, he raised taxes sharply to provide much-needed revenue and moved aggressively to promote incentives to entice wealthy investors, like the hedge fund billionaire John Paulson, who has invested in an exclusive beach resort and condo complex.”
(emphasis added)
The workers he didn't want to lay off are of course government employees. In other words, net consumers of the wealth others produce (government doesn't produce anything of value – if it were, it would not need to obtain its revenue by coercion).
And if at the same time, he moved to 'entice billionaires' like John Paulson to invest, he obviously has to get tax revenue from someone other than billionaires. The 'sharply raised taxes' have have thus hit small business and the middle class the hardest. Some of the tax impositions are so bizarre as to defy belief:
“His tax increases have hit some businesses hard, which could pose a further drag on the economy. Among the many taxes he initiated, the governor raised the corporate tax rate to a maximum of 39 percent. Last year, the economy continued on a slide. “The new administration has a bookkeeping mentality as opposed to an economic development mentality,” said Pedro Pierluisi, Puerto Rico’s nonvoting representative in Congress and a political opponent of the governor.“Here you find Puerto Rico with an underlying economic problem charging its corporations — its job creators — 39 percent. Hello!”Perhaps the most maligned is the new lucrative gross receipts tax, which some owners of small- and medium-size businesses say threatens to put them out of business. Because of the way the tax is structured, it affects companies with less than a 5 percent net profit margin. This means that many food-related companies, like supermarkets, and new businesses, are hit hardest. The smaller the margin, the higher the tax.Some stores are paying an effective tax rate of 130 percent,said Manuel Reyes Alfonso, the vice president of a trade association that represents the food industry. If the tax is not revised, some will be forced to shut down and others will have to raise prices, he said. “It is absurd,” said Mr. Reyes Alfonso. “It’s like selling the car to buy gas.”
(emphasis added)
A 130% tax rate? Yes, that is going to work out for sure. The lower one's profit margins the more tax one is forced to pay? We wonder who came up with this stroke of governmental genius.
Conclusion
Frankly, it is a complete mystery to us how a small territory enjoying all the advantages of being part of the US while remaining largely self-administered, sporting an inviting climate and endowed with great natural beauty, could ever be so insanely mismanaged that it ends up with an unbearable debt burden and an economy that seems caught in an unending downward spiral. It must have taken a real effort to bugger such excellent starting conditions up.
The global crisis that began in 2007/8 has unmasked many unsustainable economic dispositions. Unfortunately, the proper conclusions have still not been arrived at, as evidenced by the fact that the same old Keynesian recipes that have failed over and over again are being implemented on an even grander scale. One must not be misled by the claims of 'austerity' being imposed, as this has evidently little bearing on government spending as such, but is rather an attempt to squeeze more blood out of an already shriveled turnip, namely what remains of the private sector. Puerto Rico seems – at least so far – not any different in that respect.
Puerto Rico’s debt limit
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One of the most interesting points that Puerto Rico Governor Alejandro Garcia Padilla made in a speech on Monday after the credit rating downgrades by Standard & Poor’s and Moody’s (Fitch has since also downgraded Puerto Rico to speculative grade) is related to the restructuring of Puerto Rico’s tax code. He said:
In less than a year, propose a new tax structure allowing the best balance between all sectors of the country and promote economic development. These studies include the revaluation of the SUT to explore if it is the best alternative for all, taking into account the debt issued against that source.
SUT is the “sales use tax” that is the repayment source for $15.5 billion of Cofina debt. This debt is generally considered highly secure because of the legislative pledge of SUT revenues.
There had been discussion of Puerto Rico issuing another tranche of Cofina bonds that would have a third lien on SUT revenues, but SUT revenues have been coming in lower than projected as the economy contracts. I’ve questioned if there were sufficient revenues to leverage another bond offering on this revenue source. Puerto Rico has since announced it would switch and bring a general obligation bond to market rather than a Cofina offering.
A general obligation offering presents its own problems.
The primary problem is the Constitutional limit on the amount of general obligation debt that can be issued. The Government Development Bank (GDB) describes how Section 2 of Article VI of the Puerto Rico Constitution says debt cannot be issued if the payment of principal and interest on “direct obligations of the Commonwealth” exceeds 15 percent of “average annual revenues raised under the provisions of Commonwealth legislation” for the two previous fiscal years. “Direct obligations of the Commonwealth” are the $11.5 billion in general obligation debt of Puerto Rico.
Puerto Rico revenues are projected to be $9.5 billion for fiscal year 2014 (page 3), but they would not be included in the calculations. Revenues were $7.785 billion for 2013 (page 13) and $8.667 billion for 2012 (page 44). For the two previous fiscal years, average annual revenues were $8.239 billion. 15 percent of these revenues would be $1.234 billion. This would suggest adequate debt capacity to issue new general obligation debt since 2012 debt service was $964 million and Puerto Rico did not issue any new general obligation debt in 2013.
But the Constitution has caveats on the taxes that are used to determine the revenues in the 15 percent debt limit. From the GDB again (emphasis mine):
Section 2 of Article VI does not limit the amount of debt that the Commonwealth may guarantee so long as the 15 percent limitation is not exceeded through payments by the Commonwealth on such guaranteed debt. Internal revenues consist principally of income taxes, property taxes and excise taxes. Certain revenues, such as federal excise taxes on offshore shipments of alcoholic beverages and tobacco products and customs duties, which are collected by the United States Government and returned to the Treasury and motor vehicle fuel taxes and license fees, which are allocated to the Highway and Transportation Authority, are not included as internal revenues for the purpose of calculating the debt limit, although they may be available for the payment of debt service.
The definition also excludes SUT revenues that are pledged to repay Cofina debt. Constitutional debt limit exemptions reduce general fund revenues available for debt service by 7 percent, on average. Here are the historic debt limitations from the 2012 CAFR (page 292).
The 2013 CAFR has not been published, so we don’t have a debt limit calculation for fiscal year 2013. But if we subtract 7 percent from 2013 general fund revenues of $7.785 billion, we get $7.24 billion. Adding this amount to 2012 general fund revenue of $8.092 billion would average $7.66 billion. 15 percent would be $1.149 billion of allowable maximum debt service for the current fiscal year.
Debt service for 2014 is projected to $927 million (PDF page 14). Subtracting $927 million from $1.149 billion would leave just $222 million of new additional debt service that Puerto Rico could take on and comply with Constitutional requirements.
It’s unclear how large a new general obligation offering will be and what interest rate investors will demand to buy the deal. Some reporting has suggested a $3.5 billion offering. It doesn’t appear that the Commonwealth has the debt capacity for an offering of this size if interest rates breach 8 percent ($280 million of annual debt service). Puerto Rico more likely has the capacity to bring $2.5 billion of general obligation debt at 8.5 percent (about $212 million of additional annual debt service).
The Puerto Rico general obligation yield curve remains inverted:
Finding maturities and yields for the new offering that brings annual debt service under the Constitutional limit may be a difficult process.
Puerto Rico will hold an investor call on Tuesday, February 18th at 2:00 pm EST. A debt limit discussion would be useful for both potential and current investors.
The Debt Crisis in Puerto Rico: Why Is It Not More Newsworthy?
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By Robert E. Prasch, Professor of Economics at Middlebury College. Originally published at New Economic Perspectives
Anyone who follows the news periodically, if not more often, wonders about the criteria making certain issues or persons “newsworthy,” and others substantially less so. One reliable indicator of newsworthiness is that the story happens in Washington, D.C. A second is an unusual or counter-intuitive event (“Man bites dog”). A third is the prospect of large losses. This last quality, however, renders the relative neglect of Puerto Rico’s debt crisis an interesting anomaly.
To get a sense of this conundrum, let us reflect back on the extensive coverage preceding Detroit’s Chapter 9 bankruptcy this past July. At the time of its filing, Detroit was a city of 700,000 persons, down from 887,000 as recently as 2005, and 1.2 million in 1980. The mass media began to cover the story months before the city’s formal declaration of bankruptcy. A common feature of these stories was that Detroit’s filing was by far the largest muni-debt bankruptcy in U.S. history, with an estimated $18 billion on the line (Jefferson County, AL and Orange County, CA were a mere $4.2 and $1.6 billions respectively). We saw numerous stories about the demise of a once-great city, the politics surrounding the payment crisis, and a fairly robust investigation into the plight of the city’s pensioners, residents, home owners, and sundry other stakeholders.
By contrast, Puerto Rico has a much larger population with approximately 3.7 million residents. As with Detroit or any other location under economic pressure, its population has been shrinkingrapidly, by about 1% per annum since 2010. This is not too surprising since Puerto Rico’s GDP has only recently begun to stabilize after contracting in every year since 2006. A large portion of this contraction is due to greatly reduced levels of investment and construction, along with stagnating “exports” to its primary trading partner, the United States. Unsurprisingly, its “headline” unemployment rate is 15.4%, much higher than any state in the Union. While I have not become aware of any substantive data on the demographics of those who have left and those who have stayed, similar economic stresses across other cities and regions make it safe to presume that those who have departed are younger, more educated, and more employable.
As to the crisis itself, depending upon whom you read, somewhere between $55 and $70 billion of municipal or “muni” debt is at risk of default. Of this, just shy of $1 billion must be paid out or refinanced over the next month. In light of the market’s bearish turn on Puerto Rican debt, this will be neither easy nor cheap. As an index of market sentiment, consider that yields on Puerto Rico’s 20 year bonds, which were around 5% as recently as May, have now surged to over 10%. The market’s sense that Puerto Rico’s debt load is unmanageable was given additional impetus this past week when S&P and Moody’s downgraded the ratings on the Commonwealth’s bonds to “junk.”
With its population and economy shrinking, yields on its debt increasing, tax levels rising, businesses struggling, and bond market sentiment becoming notably bearish, Puerto Rico is in a terrible bind. To add to its woes, legal opinion currently holds that as Puerto Rico is not a sovereign government, it most likely does not have the legal authority to file for bankruptcy. Such an inability means that it cannot use the threat of a filing to garner leverage in working out terms with its creditors, and it cannot count on an informal deal freeing it up from predations by “vulture funds.”
Given all of the above, why is this story not more newsworthy (a late exception is this Sunday’sNew York Times)? If we merely consider the size of the problem, it should be evident that more people will be directly afflicted by cuts in government services, lower pension payments, and a weakened labor market, etc., than occurred as a consequence of the collapse of Detroit’s or Jefferson County’s finances.
To be certain, some stories have appeared – almost all of them in the business press. The “angle” has been almost entirely on the financial side – the ratings downgrades, the outlook for investors, the efforts on the part of the government of Puerto Rico to balance its budget, etc. Again, with a few exceptions, we have not seen any “personal interest” or “man on the street” articles featuring interviews with pensioners, residents, small business owners, school officials contemplating more budget cuts, or individuals contemplating migration to the New York, Miami, or elsewhere.
I would speculate that part of the reason for the coverage gap is the absence of two U.S. Senators and a handful of Representatives. Representation in Congress would make this a Washington story, and thereby “on the radar” of all political reporters and most newspaper editors. Another reason may be related to Puerto Rico’s quasi-sovereign status.
Or, is it that we are becoming accustomed to such stories? Perhaps we have quietly given up on the notion that the United States is or should be a first-world nation with the ability, capacity, and obligation to ensure that all of its states and territories have the wherewithal to support a decent standard of living. If the latter is true, then the lack of interest in the prospects facing the people of Puerto Rico is just one more signal that plutocratic values and perspectives are increasingly dominating our politics and media.
FITCH RATINGS DOWNGRADES PUERTO RICO'S DEBT
— Feb. 11, 2014 4:55 PM EST
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FILE - In this Saturday, Feb. 1, 2014, file photo, Surfers carry their boards over rocks to get to their surfing spot called La Boca, or The Mouth, in Barceloneta, Puerto Rico. The last of three major credit rating agencies downgraded Puerto Rico's debt by two notches to junk status on Tuesday, Feb. 11, 2014. (AP Photo/Ricardo Arduengo, File)
SAN JUAN, Puerto Rico (AP) — The last of three major credit rating agencies downgraded Puerto Rico's debt by two notches to junk status Tuesday.
Fitch Ratings praised the U.S. territory for responding quickly to economic challenges but noted the economy remains weak and its access to the bond market is impaired.
Puerto Rico's government says it plans to issue general obligation bonds soon, although it is unclear how much debt will put on sale or on what date.
David Chafey, chairman of Puerto Rico's Government Development Bank, said Tuesday only that the bonds would be issued in the "near term." He said Barclays, Morgan Stanley and RBC Capital Markets will be the underwriters for the bond sale.
Fitch said that Puerto Rico's bonded debt levels and unfunded pension liabilities are very high compared to U.S. states and that recent downgrades have led to a potential $1 billion in new liquidity demands.
"Puerto Rico's current management has repeatedly shown its ability and willingness to take quick action to address financial challenges and external market concerns," Fitch said. "However, underlying the need for these measures is the very difficult economic, financial and market situation that management continues to confront."
Standard & Poor's and Moody's downgraded the island's credit rating last week.
Puerto Rico has assured investors that it will not default on $70 billion in public debt. Puerto Rico's bonds are popular with U.S. investors because they are exempt from federal, state and local taxes, and its debt is held by roughly 70 percent of U.S. municipal mutual funds, according to Morningstar.
David Tawil, co-founder and portfolio manager of New York-based Maglan Capital, said Puerto Rico will now have to tap into a different set of lenders in the next few years, including hedge funds and banks.
"It is no longer your average municipal bond holder," he said in a phone interview. "It's going to be much more strategic, much more active type of investors."
Fitch announced its downgrade one day after Gov. Alejandro Garcia Padilla unveiled several measures to help boost Puerto Rico's economy as the island of 3.7 million people battles its eighth year in recession and a 15.4 percent unemployment rate, higher than any U.S. state.
Treasury Secretary Melba Acosta said she was disappointed by Fitch's decision, while Garcia's administration announced it was pushing back by almost one week a webcast to update investors on Puerto Rico's fiscal and economic plans.
Garcia has previously taken steps to strengthen the government's balance sheet, including increasing taxes and authorizing changes to struggling public pension systems.
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