Latest / Trumponomics / 36: Puerto Rico's $70 Billion Crisis Just Might Be Catastrophic

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36: Puerto Rico's $70 Billion Crisis Just Might Be Catastrophic · Trumponomics

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  Speaker 1: Then eventually Puerto Rico would need for Congress to actually
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  Speaker 1: right out at check. So the thing that Congress is
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  Speaker 1: trying desperately to avoid may happen because Congress is trying
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  Speaker 1: so hard to Hi and welcome back to Bloomberg Benchmark,
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  Speaker 1: a show about the global economy. It's Thursday, May five.
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  Speaker 1: I'm Daniel Moss, executive editor for Global Economics in New York.
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  Speaker 1: Our Benchmark editor, Akio most exciting is back from her
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  Speaker 1: three months in Tokyo. Who it's good to be back.
• 0:40
  Speaker 1: It's great to have you back, and it almost compensates
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  Speaker 1: for Tori not being with us this I am no
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  Speaker 1: replacement for Tori. Well, this week, a small Caribbean island
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  Speaker 1: has been making big news at least in the world
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  Speaker 1: of finance and economics. And hey, that's the only world
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  Speaker 1: there is right over the past decade or so, the
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  Speaker 1: UST territory of Puerto Rico, that's very important. We'll come
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  Speaker 1: back to a second. The US territory of Puerto Rico
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  Speaker 1: has been on an absolute debt, being racking up seventy
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  Speaker 1: billion dollars worth of the stuff the context. That's more
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  Speaker 1: than any U. S state government except for California. In
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  Speaker 1: New York both huge, yet Puerto Rico is tiny. So
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  Speaker 1: what's the problem? The times arrived for Puerto Rico to
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  Speaker 1: start paying those borrowings and it can't right and as
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  Speaker 1: the crisis here in Puerto Rico unfolds, I think a
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  Speaker 1: lot of our listeners are, you know, asking themselves, how
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  Speaker 1: does a default from this tiny island in the middle
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  Speaker 1: of the Caribbean affect me? But there's a pretty good
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  Speaker 1: chance that it does. If you're an American taxpayer, for example,
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  Speaker 1: you should definitely be paying attention. If you own mutual
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  Speaker 1: funds through maybe something like You're four one K, you
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  Speaker 1: should be paying attention. And if you're fascinated by these
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  Speaker 1: kinds of situations where governments borrow too much money and
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  Speaker 1: Wall Street kind of ended up in neighbor billing them,
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  Speaker 1: enabling a kind of behavior you should be paying attention to.
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  Speaker 1: I think one of the first points you made was
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  Speaker 1: a good one. It's important for everyone to remember Puerto
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  Speaker 1: Ricans are US citizens. It is a US territory. So
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  Speaker 1: today we'll talk about how the island got itself into
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  Speaker 1: this situation, but more importantly, what happens from here and
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  Speaker 1: to do that, you have our Bloomberg colleague Michelle Caski
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  Speaker 1: joining us. Michelle covers the municipal bond market, and for
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  Speaker 1: the past couple of years she's been focusing entirely on
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  Speaker 1: Puerto Rican debt. That makes her the equivalent of our
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  Speaker 1: chief Puerto Rico correspondent. It's so great to have you here.
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  Speaker 1: Thanks for having me, Michelle. Halften. Do you get to
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  Speaker 1: go out there on expensed reporting trips every few months?
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  Speaker 1: It tends to be like a couple of times a year.
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  Speaker 1: I'll head down there and talk with people and meet
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  Speaker 1: with local officials and lawmakers and business folks, and it's
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  Speaker 1: usually it's a lot of work, but it's also such
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  Speaker 1: a beautiful place and food, so it's a fun time
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  Speaker 1: as well. Amazing well, Michelle, Puerto Rico is a place
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  Speaker 1: that we usually associate with, you know, beautiful beaches, coral reefs, rainforests,
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  Speaker 1: fors in cocktails. Now all anyone is talking about is
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  Speaker 1: it's that problem. How did we get here? Do you
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  Speaker 1: want to start? Sure? It started around roughly around two thousand,
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  Speaker 1: where the government down there started to borrow to help
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  Speaker 1: balance its annual operating budget, and over the years this
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  Speaker 1: has continued. Every single year from both political parties, different administrations.
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  Speaker 1: This practice just kept on going and it didn't stop.
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  Speaker 1: And so what we have today is a combined seventy
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  Speaker 1: billion between the central government, their director at end, and
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  Speaker 1: agencies on the island. Now that in itself is something
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  Speaker 1: wrong with that. I mean, state governments in the mainland
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  Speaker 1: do it all the time right to cover budget shortfalls,
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  Speaker 1: as does the federal government. Well on the state level.
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  Speaker 1: If they do it, it tends to be temporary, maybe
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  Speaker 1: for a year or two during very during a downturn.
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  Speaker 1: But for Puerto Rico, they made it basically a habit
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  Speaker 1: that they couldn't break. So that's what's different here. That's
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  Speaker 1: what's different. And part of the reason it's had to
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  Speaker 1: borrow so much is because its economy has been in
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  Speaker 1: recession for such a long time, right it has um
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  Speaker 1: back in Congress decided to start phasing out some federal
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  Speaker 1: tax breaks that larger manufacturers on the island were receiving.
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  Speaker 1: These are namely pharmaceuticals, and that phased out in roughly
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  Speaker 1: around two thousand and six, and two thousand and six
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  Speaker 1: is when really the downturn started. And for every year
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  Speaker 1: but one uh their economy has contracted and they're now
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  Speaker 1: they're they're unemployment rate is almost twelve. Well. One of
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  Speaker 1: the ways also that Puerto Rico was able to rack
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  Speaker 1: up this seventy billion is their debt over the years
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  Speaker 1: has been very attractive to the municipal bond market. It's
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  Speaker 1: tax exempt for anyone living in the US, So whether
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  Speaker 1: you're a resident of Wisconsin or New York or or Colorado,
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  Speaker 1: you can buy Puerto Rico bonds and they will be
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  Speaker 1: tax exempt for you. And these are federal, state and
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  Speaker 1: local taxes. Definitely, that's yeah the phrase that we've been hearing. Definitely,
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  Speaker 1: and their yields were higher relative to what you would
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  Speaker 1: see for other municipal bonds, state level municipal bonds. So yes,
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  Speaker 1: people knew it was a risky or risky or bond
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  Speaker 1: to buy, but they felt that they were being compensated
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  Speaker 1: and they felt secure that Puerto Rico would never default
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  Speaker 1: on in particular, it's direct debt um it's general obligations
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  Speaker 1: which are guaranteed by the by the Islands Commonwealth for repayment.
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  Speaker 1: So the muni market was there, definitely there to lend
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  Speaker 1: the money and Puerto Rico, instead of learning to live
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  Speaker 1: within its means continue to use Amuni market in order
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  Speaker 1: to keep things afloat. So how much of this can
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  Speaker 1: be traced to the fuzzy status that Puerto Rico enjoys.
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  Speaker 1: And by fuzzy, I mean it's part of the United States,
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  Speaker 1: it's a United States territory. It's residents are US citizens.
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  Speaker 1: They don't have to stay in Puerto Rico. They can
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  Speaker 1: go to California, Florida, New York, whatever. You can even
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  Speaker 1: vote in a Republican and Democratic presidential primary in Puerto Rico.
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  Speaker 1: But yet it has certain disadvantages because it's not treated
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  Speaker 1: the same way that Indiana or Oregon or Mississippi are treated. Right,
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  Speaker 1: they have no voting members of Congress, they have no senators.
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  Speaker 1: So it's neither fish nor foul. To what extent has
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  Speaker 1: does that lie at the root of the problems It's
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  Speaker 1: got now for Puerto Rico to work its way out
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  Speaker 1: of this. One tool that it doesn't have, which states have?
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  Speaker 1: States have the ability to declare after nine or municipal
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  Speaker 1: bankruptcy u S states. Although the states themselves cannot declare bankruptcy,
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  Speaker 1: their entities can, So, for instance, Detroit declare bankruptcy, but
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  Speaker 1: the state of Michigan would not be able to declare bankruptcy.
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  Speaker 1: On the island of Puerto Rico, no municipality or utility
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  Speaker 1: can declare bankruptcy. So they don't have a way to
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  Speaker 1: work out their debt. They don't have a legal framework
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  Speaker 1: to do that. They can default, but but then then,
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  Speaker 1: but then it's just all these legal suits. So what
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  Speaker 1: Puerto Rico is trying to do now is to get
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  Speaker 1: Congress to either allowing Chapter nine, which looks like now
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  Speaker 1: they're not going to get, or for Congress to create
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  Speaker 1: a legal framework so Puerto Rico can restructure its debts
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  Speaker 1: and move on and get past this. Well, that brings
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  Speaker 1: us to where we are now. It's economy is contracting
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  Speaker 1: and contracting at a very significant right. The poverty rate
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  Speaker 1: is forty five percent now, that's about three times the
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  Speaker 1: level on the mainland. And it's residents who are US
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  Speaker 1: citizens aren't obliged to stick around Puerto Rico and they're not,
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  Speaker 1: so there's an ever shrinking tax base there as well. Yeah,
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  Speaker 1: and Puerto Rico has known since last year that they
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  Speaker 1: were in trouble, and they turned to Washington for help.
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  Speaker 1: Puerto Rico missed a four hundred million dollar payment on
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  Speaker 1: debt that matured on Sunday, May one, and that could
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  Speaker 1: lead to larger and more consequential defaults. We're going to
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  Speaker 1: take a quick break and when we get back, we'll
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  Speaker 1: talk about where we go from here, what the options are,
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  Speaker 1: and what the implications could be. Puerto Rico faces a
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  Speaker 1: cascade of default starting in July unless Congress passes legislation
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  Speaker 1: that helps the commonwealth restructure its debt. Now that sound scary,
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  Speaker 1: Michelle walk us through this. Part of the problem is
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  Speaker 1: that Congress now is under a deadline because Puerto Rico
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  Speaker 1: and its agencies oh two billion dollars on July one,
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  Speaker 1: and of that about eight hundred million is for their
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  Speaker 1: General Obligation debt. Now, the default that happened on May one,
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  Speaker 1: that was the Government Development Bank that isn't direct debt
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  Speaker 1: of the commonwealth, so it was their largest default so far.
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  Speaker 1: But what would really change the game here is if
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  Speaker 1: they were to default on their General Obligation or GEO
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  Speaker 1: debt on July one. Those bonds have the strongest legal pledges,
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  Speaker 1: so investors, you really could see a lot more lawsuits
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  Speaker 1: come July one if there's a default on that debt right,
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  Speaker 1: and I think none of us would want to rely
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  Speaker 1: on Congress for a speedy solution here. But I think
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  Speaker 1: a lot of our listeners are wondering why Puerto Rico
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  Speaker 1: even needs Washington for this. Why can't they just declare
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  Speaker 1: bankruptcy like Detroit? Why can't they go to the I
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  Speaker 1: m F? UM like Grease did you went into this
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  Speaker 1: a little bit earlier? But tell us now? Sure they
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  Speaker 1: can't go to the I m F because they're part
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  Speaker 1: of the United States government, and um, this needs to
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  Speaker 1: be worked out within our own country. And unfortunately, without
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  Speaker 1: access to municipal bankruptcy, Puerto Rico doesn't have a tried
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  Speaker 1: and true method for working out a debt restructuring And
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  Speaker 1: so now it's up to Congress, and only Congress can
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  Speaker 1: can enact and pass bankruptcy type legislation. So what Congress
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  Speaker 1: is doing now is a bill. The bill would actually
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  Speaker 1: allow US territories to It gives it gives them a
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  Speaker 1: way to negotiate with investors and reduce debtloads. And why
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  Speaker 1: can't they go to that IMF because Puerto Rico is
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  Speaker 1: part of the US government. So it gets worked out
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  Speaker 1: within our own country. It's not its only sovereign, sovereign country.
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  Speaker 1: So again we've got this neither fish nor foul status
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  Speaker 1: that gets in the way. Puerto Rico is part of
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  Speaker 1: the US. It's part of the country, but it is
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  Speaker 1: not a state in the same way that New York
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  Speaker 1: or Texas or California is. Ultimately, when this is sorted out,
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  Speaker 1: when we write the history of it in twenty or
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  Speaker 1: thirty years time, would this be seen as a seminal
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  Speaker 1: event that pushed Puerto Rico further towards statehood or had
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  Speaker 1: the opposite effect, pushed it away. That's really hard to
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  Speaker 1: say now because right now people are focused on just
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  Speaker 1: resolving Puerto Rico's financial mess and the idea of should
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  Speaker 1: Puerto Rico become a state, should it remain a commonwealth
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  Speaker 1: maybe with some tweaks and changes it That really isn't
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  Speaker 1: the driving force here. What people are most focused on
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  Speaker 1: is the immediate problem, which is is to get Puerto
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  Speaker 1: Rico's finances back on track to get their economy growing again.
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  Speaker 1: Oh sure, I mean sometimes the long time consequences of
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  Speaker 1: things aren't apparent at the time and we look back
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  Speaker 1: and we say, gosh, well that was a real turning point.
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  Speaker 1: I think the turning point for Puerto Rico is more
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  Speaker 1: of they need to make this transition to having more
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  Speaker 1: more jobs created through the private sector rather than government
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  Speaker 1: jobs on the island. The government as of now is
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  Speaker 1: the is the largest employer on the island and so
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  Speaker 1: for that to change and for there to be more
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  Speaker 1: public sector jobs would really help them out a lot
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  Speaker 1: and help their economy grow. And so that's sort of
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  Speaker 1: the transition they need to make. And Congress is not
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  Speaker 1: the only DC institution with a finger in this pie.
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  Speaker 1: The Supreme Court is involved as well. Tell us about that. Yeah,
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  Speaker 1: that's a whole another story within the largest story. And
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  Speaker 1: about two years ago, Puerto Rico passed its own local
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  Speaker 1: restructuring law which would allow the island to restructure namely
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  Speaker 1: utility debt, so their electric company dead or water utility debt.
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  Speaker 1: If any of those types of agencies wanted to reduce
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  Speaker 1: their debtload, they could through this local law that passed.
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  Speaker 1: But it was immediately challenged by some investors and a judge,
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  Speaker 1: federal judge on the island did throw it out. Are
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  Speaker 1: these investors mostly you know kind of people are in
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  Speaker 1: Wall Street? Are they hedge funds? And things like that
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  Speaker 1: it's a combo of mutual funds and also hed a
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  Speaker 1: hedge fund. And Puerto Rico kept appealing this and it
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  Speaker 1: made its its way all the way to the Supreme Court.
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  Speaker 1: Earlier this year, the Supreme Court had a hearing on
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  Speaker 1: on this case. And we're anticipating the Supreme Court to
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  Speaker 1: rule by the end of June, and they could conceivably
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  Speaker 1: bring back to life this local debt restructuring law, which
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  Speaker 1: would put tools again in the hands of of Puerto Rico.
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  Speaker 1: Do you think Congress is going to punt and white
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  Speaker 1: for the court. Let's see if let's say we have
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  Speaker 1: through June. If if Supreme Court makes the ruling, we're
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  Speaker 1: already in May, maybe they could. But but members are
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  Speaker 1: are getting back from recess on May ten, and the
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  Speaker 1: there's a House Natural Resources Resources Committee, which is they're
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  Speaker 1: the ones drafting the Puerto Rico bill. They say that
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  Speaker 1: next week there will be a fresh version of the
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  Speaker 1: bill ready to go for for folks to work on.
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  Speaker 1: So it is possible that Congress is just planning to
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  Speaker 1: keep moving forward regardless of of what the Supreme Court does.
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  Speaker 1: Quickly walk us through the best and worst case scenarios.
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  Speaker 1: For how this plays out, sure, I think worst case
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  Speaker 1: scenario is that Congress is unable to pass legislation. They
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  Speaker 1: can't get enough votes for a bipartisan bill to really,
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  Speaker 1: you know, to get this to the President's desk for
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  Speaker 1: his signature, to allow Puerto Rico to the clare bankruptcy well,
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  Speaker 1: to allow them to give them that legal framework to
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  Speaker 1: work through their debts. So if Puerto Rico doesn't have
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  Speaker 1: that option, then they're on their own, and that means
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  Speaker 1: they continue to there will be more defaults, which would
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  Speaker 1: in turn means more legal suits and legal battles, which
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  Speaker 1: will take a lot of time and energy away from
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  Speaker 1: Puerto Rico from governing itself and and um and looking
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  Speaker 1: out for the safety and welfare of its citizens. And
• 15:16
  Speaker 1: you know, if Puerto Rico can't declare bankruptcy, obviously its
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  Speaker 1: economy is going to get a lot worse. We could
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  Speaker 1: see a real decline in living conditions. It's kind of ironic,
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  Speaker 1: um that this would end up probably requiring a federal
• 15:31
  Speaker 1: government bail out in this case, and American taxpayers would
• 15:34
  Speaker 1: be on the line for that. So there's some lawmakers
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  Speaker 1: who are saying, look, if Congress doesn't get a bill
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  Speaker 1: passed now. This bill passed now, which currently does not
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  Speaker 1: specifically allocate funds to Puerto Rico, then eventually Puerto Rico
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  Speaker 1: would need such such help and actually for Congress to
• 15:53
  Speaker 1: actually right out a check. So the thing that Congress
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  Speaker 1: is trying desperately to avoid might happen be because Congress
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  Speaker 1: is trying so hard to If if they're not able
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  Speaker 1: to get this bill through, then then Puerto Rico is
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  Speaker 1: definitely more at risk of needing actual, real cash from
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  Speaker 1: from the federal government. And what's the best case scenario.
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  Speaker 1: Best case scenario is that Congress actually does get a
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  Speaker 1: bill passed that everyone can live with and that actually
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  Speaker 1: helps Puerto Rico and the investors all come to the
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  Speaker 1: table agree on certain haircuts and reduction of debt, maybe
• 16:32
  Speaker 1: pushing out maturities, and and that would that would allow
• 16:37
  Speaker 1: the Commonwealth to be able to okay, get on track
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  Speaker 1: with having this a debt plan, to repay its creditors
• 16:45
  Speaker 1: and at the same time rebuild its economy and really
• 16:48
  Speaker 1: get that economy growing again. Now, that'll that'll take time.
• 16:54
  Speaker 1: That that would still take time, but at least they
• 16:56
  Speaker 1: would be moving forward instead of just staying in this
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  Speaker 1: one spot which they are now. Yeah, well I have
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  Speaker 1: my fingers cressed. Michelle, thanks so much for joining us today.
• 17:05
  Speaker 1: Thanks for having me, and if you ever need a
• 17:08
  Speaker 1: travel buddy for a reporting trip, I am definitely game. Louisa,
• 17:12
  Speaker 1: you just go back from three months in Tokyore. That
• 17:15
  Speaker 1: sounds great. Need this Miles Benchburg will be back again
• 17:19
  Speaker 1: next week and then until then. You can find us
• 17:21
  Speaker 1: on the Bloomberg terminal and on Bloomberg dot com, also
• 17:24
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• 17:27
  Speaker 1: take a minute to rate and review our show. Some
• 17:30
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• 17:32
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• 17:34
  Speaker 1: and follow us on Twitter at Akito seven and at
• 17:37
  Speaker 1: Daniel mass TC, and our guest is on Twitter at
• 17:41
  Speaker 1: Michelle Caski. We'll see you next week. Thank you. I
• 17:45
  Speaker 1: love this conversation. Do come back. Thank you, thanks for
• 17:48
  Speaker 1: having me.