USA TODAY International Edition
Puerto Rico may affect you, too
Island’s move could affect investments, mainland politics
Puerto Rico’s bankruptcy is poised to bludgeon investors, threaten the livelihood of American citizens who planned their retirement on the island’s promises, and undermine state governments.
The bankruptcy might also provide hope of fiscal sustainability and improved services for Puerto Rico, as the U. S. territory attempts to dig out of $ 74 billion in debt and $ 49 billion in pension promises.
But the ripple effects remain shrouded in uncertainty as the U. S. judicial system runs, for the first time, a debt- cutting legal process known as Title III of a 2016 law dubbed the Puerto Rico Oversight, Management and Economic Stability Act.
“Nobody really knows exactly what’s going to happen,” S& P Global Ratings credit analyst David Hitchcock said. “It’s highly uncertain.”
An oversight board governing Puerto Rico will aim to negotiate debt- cutting deals with creditors with the goal of achieving a viable “plan of adjustment” that a federal judge deems reasonable and fair.
But previous municipal bankruptcies have demonstrated that the clash among Wall Street creditors, mom- and- pop vendors, retirees, politicians, union officials and special interests is a recipe for inertia.
“I don’t know that a dawn is coming, but it’s going to get darker,” Municipal Market Analytics analyst Matt Fabian said.
What’s clear, however, is that in the absence of action Puerto Rico’s downward spiral will continue, as the island’s economy remains distressed and as thousands of people flee to the mainland.
To many Americans, Puerto Rico is a vacation spot and nothing more. But this bankruptcy could hit closer to home than they realize. Here’s why:
uFellow Americans could continue to suffer. Puerto Ricans are American citizens. They are suffering under the weight of heavy debt, bureaucracy, high taxes and poor access to economic opportunity.
This bankruptcy could lead to their pensions and health care insurance taking hits, while services could also suffer cuts. Fabian estimated some pensioners might get cuts of up to 20%.
But that may be necessary to help stabilize the island. Puerto Rico has lost 20% of its jobs since 2007 and 10% of its population, sparking an economic crisis that worsens by the day.
Without action to improve ser-
vices such as public safety, health and education, the island’s population loss could continue or even accelerate. uYour retirement investments may take a hit.
Since Congress voted 100 years ago to exempt Puerto Rican bonds from federal, state and local taxes, those investments have attracted many people seeking tax- free retirement income.
Despite years of trouble, more than 40% of U. S. municipal bond funds still have exposure to Puerto Rico’s debt, totaling $ 7.82 billion in holdings, according to Morningstar data.
What’s more, U. S. mutual funds hold about $ 8.38 billion in Puerto Rico debt, according to Morningstar.
Those bonds could be subject to steep cuts in bankruptcy, and while insurance might cover some of those losses, anyone who bet their portfolio on Puerto Rico should be nervous.
The bankruptcy “could have the advantage of a potentially global solution that might arrive more quickly and with lower legal costs, but it also strengthens Puerto Rico’s protection against legal claims,” Hitchcock said in a
research bulletin. uIt might be more expensive for your state to borrow.
Puerto Rico’s crisis shows that large governments can reach a point of no return, endangering investment principal.
That may give investors pause before they acquire debt from cash- strapped states and cities, Fabian said. That could increase borrowing costs for state and local governments, which must cut spending or raise taxes to make up the difference.
“I think it will make life more difficult in places like Illinois and New Jersey and Connecticut, where investors are already reluctant to loan the government money,” Fabian said.
uThe case could lead to a political eruption.
If and when discussion of pension cuts heats up, expect angry missives from members of Congress — perhaps even from lawmakers who voted to create this debt- cutting process in the first place. Others might be upset about bondholders taking cuts.
But don’t expect a bailout anytime soon. President Trump has blasted the possibility of rescuing Puerto Rico.