Puerto Rico defaults: Five things you should know

万得福

By Michael Santoli
Puerto Rico failed to meet a $58 million bond payment Monday, placing the U.S. territory in default and deepening concerns over its ability to service its $72 billion in debt.
Here are a few key points about Puerto Rico’s financial difficulties and what they might mean for investors and the economy.

Was this default a surprise?

No, investors have been bracing for a possible default for at least two years. Puerto Rico’s debt level has been building toward unsustainable levels for more than a decade.

Governor Alejandro Garcia Padilla last month stated that the $72 billion in public debt could not be paid back. Its bonds have traded at steep discounts to face value, signaling the market’s concern that a default or a debt restructuring would occur.

How did Puerto Rico get here?

Persistently weak economic performance has eroded the tax base and the government and other

agencies piled on debt from eager lenders to maintain public spending.

Puerto Rico has more than three times the debt per resident as the most heavily indebted U.S. states.

The territory suffers under certain structural disadvantages. The federal minimum wage applies there, and is probably too high for local productivity rates and prevailing wages. Able-bodied residents leave for the Mainland in large numbers. Certain trade laws make it harder to compete in manufacturing without U.S. subsidies that were lifted several years ago. And it has lost market share in tourism to nearby islands such as the Dominican Republic.

What does it mean for U.S. investors?

Puerto Rican debt was popular among some municipal-bond investors for its high relative yields and tax-free status. Only a few mutual funds are heavily concentrated in the territory’s paper, though, so a default or debt restructuring shouldn’t lead to broad investor losses.

Might the U.S. government bail out Puerto Rico?

A direct bailout is unlikely. There is speculation that the Puerto Rican government intentionally skipped the bond payment to get Washington’s attention, perhaps for the Treasury to back new Puerto Rican debt in a restructuring. And Congress could be moved to help in other ways, such as by altering bankruptcy laws to allow the territory to gain protection from creditors as it sorts out its finances.

How is Puerto Rico like, or unlike, Greece or Detroit?

Similar to Greece, Puerto Rico is linked to a larger economy with which it shares a currency and must accept fiscal direction. It therefore can’t ease debt burdens through a devalued currency, as independent nations can.

Yet there is a difference, in that Puerto Rican residents, as U.S. citizens, receive automatic help from federal income-support programs and need not accept specific fiscal direction from another government.

Like Detroit, Puerto Rico suffers from too much debt, a weak economy and steady loss of working-age population. But Detroit was able to seek protection under municipal-bankruptcy statutes. As of now, Puerto Rico does not enjoy that option.