Meanwhile, in Puerto Rico: A Silent Debt Crisis

While most of America (indeed, the world) remains wrapped up in the so-called Government shutdown and Capitol Hill budget impasse, an increasingly severe debt crisis brews silently in the non-state territory of Puerto Rico. Considered by many economists to have been mired in recession since 2006, the Puerto Rican government has managed to rack up an nearly $90 billion in debt with no realistic movement towards solvency or a balanced budget.

As the New York Times reports:

Puerto Rico, with 3.7 million residents, has about $87 billion of debt, counting pensions, or $23,000 for every man woman and child. That compares with about $18 billion of debt for Detroit, with a little more than 700,000 people, or about $25,000 for every person in the city. Detroit and Puerto Rico have been rapidly losing population, leaving a smaller, and poorer, group behind to shoulder the burden.

Detroit, at least, was able to seek relief in bankruptcy court, but Puerto Rico is in a legal twilight zone. Territories, like states, have no ability to declare bankruptcy. Another territory, the Northern Mariana Islands, tried in 2012, but its case was rejected. Top Puerto Rican officials say that the territory is not bankrupt and is working through its problems responsibly.

Puerto Rican long term bonds have taken a significant hit in recent months as the debt crisis has begun to reach a serious head, with long-term yields spiking from mid-year onward. The 20-year yield has nearly doubled from roughly 5% in May to over 10% by the present time. Recent long term yields on Puerto Rican bonds are even worse than yields on Greek bonds.

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Correspondingly, prices on 20-year bonds have taken a serious tumble within the past few months.

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Puerto Rican bonds have somehow been able to maintain an “investment-grade” status. This will not hold for much longer. Pureto Rican bonds will be downgraded to “junk” status soon enough. They already hold the lowest investment grades possible from both Moody’s and S&P. A single-notch downgrade would be all it takes to send Puerto Rican bonds into “junk” status. This would undoubtedly trigger a massive sell-off, as most investment funds are required to maintain only investment-grade bonds.

Barron’s reported back in August on the severe issues facing the Puerto Rican fiscal outlook:

“Puerto Rico’s debt load would rank third among the states, behind only California and New York. And its debt burden relative to key financial measures—gross domestic product, personal income, and population—is off the charts. Puerto Rico’s debt per capita, for instance, of $14,000 is 10 times the average of the 50 states. In addition to its debt, Puerto Rico has more than $30 billion of unfunded pension liabilities.

The backdrop in the U.S. territory isn’t promising: The economy has been in recession since 2006, the unemployment rate is 13.2%, and the budget has been structurally imbalanced for nearly a decade. The poverty rate is high, government employment accounts for a quarter of all jobs, and transfer payments make up 40% of income. More than a quarter of Puerto Rico’s nearly four million residents receive food stamps.

Puerto Rico has taken painful and politically unpopular steps to cut bloated government payrolls, raise taxes, and shore up its badly underfunded pension system. A new government elected in 2012, led by the populist Governor Alejandro García Padilla, is committed to putting Puerto Rico and its various bond-issuing authorities on a stronger financial footing. Default and restructuring aren’t in the government’s vocabulary.”

Too little too late. The bond yields clearly show that markets expect a Puerto Rican default and restructure of debt. The smart money is leaping off the sinking Puerto Rican ship.

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