Set Home | Add to Favorites | Site Map


Financial  Channel

Position:Home > Financial > International Markets >

The Origins of the Puerto Rican Debt Crisis

2017-05-04 00:56 | Network |

In a two-year long saga, the U.S. territory of Puerto Rico has made many attempts to reduce its debt burden and save its economy. However, it proved unsuccessful, and the Governor, Ricardo Rossello, has moved the crisis to a form of bankruptcy court. With over $70 billion in bond obligations and $50 billion in unfunded pensions, this is the largest government to seek bankruptcy in U.S. history.

In March, the Governor proposed a new deal to restructure debt of the premier utility company, Puerto Rico Electric Power Authority (PREPA), which constitutes $9 billion, or nearly 13% of the total bond debt outstanding. While Rosello's plan was backed by the federal oversight board (which was appointed last year by then-President Obama) to navigate Puerto Rico out of this debt trap, it was opposed by creditors.

"It affects the broader restructuring negotiations that Puerto Rico intends to conduct. So we are very concerned about what’s happening in Prepa. We’re very concerned about the possibility of that deal falling apart,” Houlihan Lokey's Steven Spencer, an adviser to creditors Franklin Advisers Inc. and Oppenheimer Funds Inc. said at the time.

The island territory had until May 1st to negotiate a deal with its creditors, at which point a stay granted by courts would expire and allow creditors to sue. On May 2nd, several creditors filed suit.

To put this in perspective, the money Puerto Rico owes represents nearly 70% of the territory's gross domestic product (GDP). For comparison, the average debt-to-GDP ratio for states in the United States is 17%. The territory's escalating debt combined with its weakening economy caused three major credit rating agencies in 2014 to downgrade Puerto Rico's debt to non-investment grade, also known as junk status. This downgrade triggered acceleration clauses with many of the territory's creditors; when this happens, principal and interest payments on debt come due much sooner. Unfortunately for Puerto Rico, its revenues are insufficient to pay its debt according to the original schedule, much less an accelerated schedule.

Last year, Lin-Manuel Miranda, the mind behind Tony and Pulitzer Prize-winning play Hamilton, made an appearance on Last Week Tonight With John Oliver to draw attention to the Puerto Rican financial crisis. He rapped, "Hoping to God John Oliver's comical dissertation resonates with the Congress that got us in this situation, along with suicidal tax incentive declarations.." The artist even joked that he would be willing to perform at Paul Ryan's house for the sake of his parent's native land.

Origins

The Puerto Rican debt crisis has many origins. Most notably, investors in Puerto Rican municipal bonds have received favorable tax treatment for years. Bond investors from all 50 states have taken advantage of this benefit by purchasing Puerto Rican bonds. When a government issues bonds, it is effectively lending money, with interest, to bondholders. Prompted in large part by this tax advantage, Puerto Rico issued too much bond debt and began relying on borrowed funds from bond issuance to balance its budget.

Economic decline in Puerto Rico has led to widening budget deficits over the years. The tiny island is ill-equipped for manufacturing and production of goods. Its economy was sustained for decades by the presence of technology and service-oriented companies that located to the island due to its favorable tax treatment. Many of Puerto Rico's tax advantages, however, were ephemeral. The U.S. tax code called for these advantages to expire over time. When that began to happen, companies fled the island, eviscerating its economy.

Compared to other states and territories, spending on social programs is disproportionately high in Puerto Rico. The majority of the island's residents receive Medicare or Medicaid. A high poverty rate in Puerto Rico invariably means a lot of its inhabitants seek welfare and other government benefits. Confounding the issue further is the fact Puerto Rico receives far fewer federal dollars to assist with social spending than states with comparable populations.

Puerto Rico has been shedding residents since 2005. The island's population is also aging. These combined factors have reduced its tax base substantially; not only has the territory taken on increasing debt in the 21st century, but it has less revenue coming in to pay that debt.

The Puerto Rican Bond Boom

The Jones-Shafroth Act of 1917 granted U.S. citizenship to residents in Puerto Rico. It also spelled out a number of stipulations defining the territory's relationship with the U.S. mainland. One of these stipulations involved Puerto Rican municipal bonds and the ways in which they would be treated differently than bonds issued by states.

Interest income on most municipal bonds is subject to taxes by various levels of government, including federal, state and local. The primary exception is when an investor purchases a bond issued by his state of residence, as in a Floridian buying a Florida municipal bond. Jones-Shafroth exempted Puerto Rican municipal bonds from all three levels of taxation; as a result, residents of all 50 states and other U.S. territories could invest in Puerto Rican bonds without paying interest on the income.

(Editor:FinAll)
User commentary
Post a comment
Comply with the policies and regulations.
Evaluation:
Verification code: Change
The latest comments In the detailed comment page>>