Homeless in Puerto Rico
The dour stone-faced German Finance Minister, Wolfgang Schaeuble made a joke this week.
“According to Bloomberg, Schaeuble said, “I offered my friend [US Treasury Secretary] Jack Lew these days that we could take Puerto Rico into the euro zone if the U.S. were willing to take Greece into the dollar union.”
Hahaha! That’s so funny Wolfie!! It’s a banker joke.
The Commonwealth of Puerto Rico, a U.S. territory defaulted this week precipitating the largest default in municipal bond history by missing a $58 million payment; it made a partial payment of only $628,000.
All of this has echos of Greece.
Puerto Richo has $72 billion in debt, equal to 100% of its GNP, more than 5 times the debt ratio of California or Texas. Greece’s debt ratio is climbing toward twice it’s GNP but it is a sovereign nation able to access various international monetary agencies. Puerto Rico is not. Greece can go back to the Drachma. Puerto Rico cannot abandon the dollar.
Both Greece and Puerto Rico are tied to a much large economy with which it shares a currency and both are in a form of death spiral, their economies shrinking as they struggle to raise ever more funds from their shrinking economies to pay the piper – err – bankers.
Puerto Rico clearly allowed a debt crisis to creep up during the boom years, when the underlying problems were hidden from view and creditors lent without a second thought, banking on an implicit guarantee from the US sovereign state that did not in fact exist.
Puerto Ricans are U.S. citizens and most learn English as well as Spanish at a very young age. They are leaving Puerto Rico in droves for the mainland; the population of the island has fallen by more than 1% each year for the last decade. As the young workers left the economy has shrunk.
Puerto Rico’s bonds were tax exempt “munies” held by many Americans through bond funds. After all, they were rated “investment grade” by those old standbys, Moodys and S&P and the United States of America would never allow Puerto Rico to default. The fact that the rates were a little better than other similarly rated bonds made the buyers even more greedy; they should have known that the increased rate usually indicates increased risk. So there is $72 billion worth of these bonds out there and no conceivable way to pay them at full value.
They began trading at a 30%+ discount – .70 cents on the dollar or lower.
Now Puerto Rico has it’s own legal system and it is not covered by U.S. bankruptcy law – therefore there is no Chapter 9 equivalent bankruptcy which, for example allowed Detroit to reorganize it’s finances in an orderly fashion.
Enter the “vulture funds” – buying up Puerto Rico bonds at substantial discounts from those who want to dump them and demanding that Puerto Rico “tighten it’s belt” and pay up.
Puerto Rico’s governor, Alejandro García Padilla, said dramatic austerity would perpetuate the island’s “vicious cycle” as the shriveling economy accelerates a mass exodus of those of working-age.
Yet the hedge fund managers have pushed home their narrative that Puerto Ricans are feckless, living beyond their means, and could easily pay if they tightened their belts. They are for example “massively overspending on education”; hundreds of schools can be closed!
Perhaps Puerto Ricans are over-eating as well.
A group of 34 hedge funds, led by Fir Tree Partners, among others, has recruited a team of former IMF officials to push their case that Puerto Rico is able to pay its debts if it reins in public spending.
Puerto Rico has recruited its own IMF champion, the former deputy director Anne Kroeger. Her report implicitly calls for a debt haircut of 35%, roughly the current price of debt trading in the secondary market, though there are many types of bonds. Others say debt relief nearer 50% will be necessary.
All this could turn into a massive legal fiasco to be fought out in the Courts of Puerto Rico.
Meanwhile the hedge fund managers are quietly betting whether or not the U.S. government will bail them out at a nice tidy profit. Alternatively they fear that Congress will extend Chapter 9 of the bankruptcy code to Puerto Rico which will prevent creditors from seizing assets willie-nillie.
Several bills are now emerging in Congress that would grant Puerto Rico “Chapter Nine” protection and weaken the hand of creditors. Presidential candidates Hillary Clinton and Jeb Bush have called for legal changes, all too conscious that this saga has become an issue for Hispanic voters — a key swing constituency.
The Hispanic vote or the Wall Street vote and money – what to do, what to do?
The U.S. acquired Puerto Rico from Spain after Teddy Roosevelt charged up San Juan Hill. Spain ceded the Philippines and Puerto Rico to the U.S. Spain also granted Cuba it’s independence, rather than cede it to the U.S.
We granted independence to the Philippines but held on to P.R. as a coaling station in the Caribbean. Neither would we grant it full statehood,
The last vote on the subject was 54% for statehood, the rest divided between the status-quo or independence. Congress will not grant statehood as P.R. would most likely enter as a solid state for Democrats.
A typical IMF study said the island should be exempted from the US minimum wage to restore competitiveness, a de facto call for an internal devaluation — an experiment pursued with varying results in Greece, Portugal, Latvia, and Ireland. We need to make these U.S. citizens poorer in order to pay the hedge fund managers their annual bonuses.
For the world, Puerto Rico is becoming a test case of whether hedge funds and financial creditors can legitimately dictate terms to sub-sovereign states, or whether there is a greater social interest in limiting their legal powers.