Thursday, May 4, 2017

Puerto Rico: A Glimpse Into The Future?

       One of the greatest fears for both preppers and government is a deep depression or outright economic collapse. Thus, preppers pay attention to what happens as governments collapse around the globe, as we've been seeing most recently in Venezuela and nations in the Middle-East, and as we saw in the former communist bloc back in the 1990s.

       I suppose that we watch or read about these scenes with a certain level of detachment because they are so far away and involve nations whose histories and cultures are very different from our own. But we are beginning to see this collapse happening closer to home, with Puerto Rico being the latest example, as it now seeks to avoid its crippling debt by seeking a form of bankruptcy. The New York Times reports that Puerto Rico is attempting to get out from under $123 billion in debt, including $74 billion in bond debt and $49 billion in unfunded pension obligations. The article goes on to observe that "[w]hile the court proceedings could eventually make the island solvent for the first time in decades, the more immediate repercussions will likely be grim: Government workers will forgo pension money, public health and infrastructure projects will go wanting, and the 'brain drain' the island has been suffering as professionals move to the mainland could intensify."

       The article continues:
While many of Puerto Rico’s circumstances are unique, its case is also a warning sign for many American states and municipalities — such as Illinois and Philadelphia — that are facing some of the same strains, including rising pension costs, crumbling infrastructure, departing taxpayers and credit downgrades that make it more expensive to raise money. 
Puerto Rico, like other states and territories, had not been authorized to seek bankruptcy protection--one of the reasons that it was able to issue debt at lower interests rates. Together with interest income from its bonds being tax free in the United States (at federal, state, and local levels), and having a constitution that put bond creditors ahead of other creditors gave Puerto Rico access to cheap credit allowing the Territory to turn to debt to finance its everyday operations.* As explained by The Week:
For decades, Puerto Rico issued bonds to cover budget shortfalls, and investors snapped them up because the bonds are exempt from federal, state, and local taxes in all 50 states. Then in 1996 the territory hit an economic crossroads. Congress ended hefty tax breaks for U.S. manufacturers operating in Puerto Rico, and American firms began shuttering their operations on the island, causing the economy to slump. Instead of restructuring its economy, Puerto Rico doubled its debt over the next 10 years, and Wall Street firms made nearly $1 billion off the fees. Those bond sales let the territory's bloated government — which employs a quarter of the workforce — meet its budgets without laying people off. But the economy remained stagnant, and the government was soon overwhelmed by its vast debt obligations.
The ultimate consequence was insolvency, which became apparent in 2015 when Puerto Rico indicated that it would no longer be able to service its debt.

       Last year, however, Obama convinced Congress to pass a law allowing the Territory some recourse to bankruptcy type protection. It is under this law that Puerto Rico is seeking protection. Not only with this proceeding mean that bond holders will likely see little of their investments, but even public employee pensioners may see cuts to their pensions.

       There are and will be lessons for everyone. For instance, the handling of Puerto Rico's debt and bankruptcy will inform cities such as Chicago on whether and how to respond to their fiscal crisis. Risk, and therefore interest, may go up for all municipal bonds as a result. And, for states such as California and Illinois, which also face significant debt problems, Puerto Rico may have established a precedent for obtaining Congressional dispensation to seek bankruptcy. If things become critical in California, Illinois, or other states, expect that they will also go to Congress for new law allowing them to seek bankruptcy protection.

       The social outcome will bear watching as well. The articles on the topic indicate that many Puerto Ricans have left the island for the mainland United States: these will, in many cases, represent some of the most productive people on the island, leaving behind an increasing number that rely on free resources provided through welfare and subsidies. Absent a bail out by the U.S., resources will continue to constrict. We should see some foreshadowing of what will play out in the some of our own cities and states.


Notes:

 * Corruption apparently also played a role. There are allegations that two members of a budget "Control Board," a body created by Congress, conspired with the Puerto Rico’s Government Development Bank (GDB), which issues the island’s government bonds, and Banco Santander, a large Spanish bank that was buying and structuring the bonds, permitting "lucrative underwriting that allowed the financially strapped island to continue borrowing huge sums, but on increasingly risky terms." Moreover:
       ... The structure of those loans, the report suggests, was more favorable to Santander and other financial institutions than to the government ― and thus the taxpayers. 
        Santander participated in the underwriting of $61.2 billion of the island’s $70 billion in debt, according to the analysis. The report estimates that more than $1 billion went toward management fees for Santander and other banks. The island shelled out another estimated $735 million to the banks to cancel interest rate swaps ― bets the government had made on future interest rates.
Besides the issuing of debt, there are conflicts of interest between government officials (both Territorial and Federal) and banks that profit from Puerto Rico not being able to resolve its debt crises.

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