Puerto Rico: Debt Crisis Cause for Bankruptcy?
On Wednesday, July 1st, Puerto Rico scrambled to make a $645.2 million debt payment. However, the cash-strapped U.S. territory remains on a path to restructuring its obligations, as Governor Alejandro Garcia Padilla has established a group of senior officials to negotiate its liabilities with creditors.
The biggest losers will be those that invested in Puerto Rican bonds. Because of tax advantages on Puerto Rican bonds, there was a substantial level of demand for them. Knowing this, the Puerto Rican government borrowed a large amount of money. For retail investors, exposure to Puerto Rican debt will likely come from investments in municipal bond funds.
The Puerto Rican government, who received a lot of money by issuing bonds with unusual tax advantages, used the proceedings to build a welfare state that was not long-term stable. If they had spent the money on infrastructure or other more useful projects, the territory would be enjoying the results of those investments. Now, as borrowing starts to become difficult, Puerto Rico has nothing but a huge pile of debt that cannot be repaid.
Another reason why Puerto Rico has fallen to a vulnerable position is the lack of its own currency. By using the U.S. dollar, Puerto Rico cannot adopt its own monetary policy. During harsh times like this, the territory cannot devalue its currency to boost its exports or tourism.
The situation is very similar to that of Greece. After joining the eurozone, Greece too had lost its monetary autonomy. And because it was in the same club with high-profile members like Germany and France, investors rushed toward Greek bonds. The idea was that if Greece had any trouble, the high-profile members would help them, or the European Central Bank would bail them out. However, as we are seeing today, Greece has put itself and the world economy in a terrible situation.
So, will Puerto Rico go down as the next Detroit? Not yet. Chapter 9 bankruptcy is only available to U.S. cities and municipal governments. As a U.S. territory, Puerto Rico does not have access to Chapter 9 bankruptcy. The future on Puerto Rico will unfold as Washington contemplates what to do with the territory.
