Puerto Rico Municipal Debt: Causes and Consequences

Puerto Rico's municipal debt crisis has been a long time coming, with roots dating back to the 1970s. The island's economy has struggled to recover from a decline in manufacturing and tourism.

The debt crisis was exacerbated by a series of bad investments, including a $3 billion bond sale in 2006 that was used to finance a power company's debt. This move was criticized for being overly ambitious and poorly managed.

The island's debt grew to over $70 billion by 2015, with a significant portion of it being held by hedge funds and other investors. This has made it difficult for Puerto Rico to refinance its debt and get back on its feet.

Puerto Rico's debt crisis has had severe consequences for its residents, including cuts to essential services and a 10% reduction in the minimum wage.

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Puerto Rico's debt crisis is a complex issue with a long history. The island's debt burden is staggering, with a combined debt and unfunded pension commitments totaling $123 billion.

The debt crisis was exacerbated by government mismanagement, including inefficiency, poor accounting, and a lack of transparency. The Department of Treasury of Puerto Rico, for example, is incapable of collecting 44% of the Puerto Rico Sales and Use Tax, resulting in a loss of around $900 million.

One of the main problems is the government's inability to set up a system based on meritocracy, with many employees, particularly executives and administrators, lacking the competencies required to perform their jobs. This has led to a situation where the government is unable to collect taxes and fees, and is instead forced to issue debt to stabilize its finances.

Here are some key facts about Puerto Rico's debt crisis:

The debt restructuring process, which was facilitated by PROMESA, has made significant progress in reducing the debt burden. The plan has reduced the Commonwealth's total debt service payments by more than 60%, from $90.4 billion to $34.1 billion, saving Puerto Rico more than $50 billion in debt service payments.

Puerto Rico's debt crisis is a complex issue with deep-rooted problems. The Puerto Rico Electric Power Authority (PREPA) has long been a source of frustration for Puerto Ricans, with its troubles predate the island's financial crisis.

The government's accounting, payroll, and fiscal oversight information systems and processes have significant deficiencies that affect its ability to forecast expenditures. Salaries for government employees tend to be quite disparate when compared to the private sector.

The Department of Treasury of Puerto Rico is incapable of collecting 44% of the Puerto Rico Sales and Use Tax (or about $900 million). This lack of effective tax collection contributes to the island's financial woes.

The government has been unable to set up a system based on meritocracy, with many employees lacking the competencies required to perform their jobs. This has led to poor governance and inefficient use of resources.

Here's a breakdown of the debt restructuring process in Puerto Rico:

The debt restructuring process has made significant progress, with several plans being confirmed by the U.S. District Court for the District of Puerto Rico.

The cessation of federal subsidies in 1996 marked a significant turning point for Puerto Rico's economy. This change was the result of President Bill Clinton signing legislation phasing out favorable tax laws.

Section 936 of the Internal Revenue Code, which had been in place for decades, allowed US corporations to operate tax-free in Puerto Rico. Companies took advantage of these provisions, generating significant investment and spending on the island.

The end of these subsidies led to a mass exodus of companies from Puerto Rico, causing economic downturn and tax shortfalls. By 2006, the ten-year phase-out was complete, and the full impact of the subsidy cessation was felt.

Puerto Rico's debt restructuring process was made possible by the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), which was signed into law in 2016. This law empowered the Financial Oversight and Management Board (FOMB) to negotiate debt restructuring with creditors and oversee the Commonwealth's budget.

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PROMESA provides mechanisms for restructuring debt, including Title III, which follows U.S. bankruptcy law, and Title VI, which requires all creditor groups to accept a plan before it can be confirmed. The FOMB has used these mechanisms to restructure debt and reduce Puerto Rico's debt service payments.

One notable example of debt restructuring is the Plan of Adjustment for the Puerto Rico Highway and Transportation Authority (HTA), which reduced HTA's $6.4 billion in claims by more than 80% and saved Puerto Rico more than $3 billion in debt service payments. This plan was confirmed by Judge Laura Taylor Swain on October 12, 2022.

Another example is the restructuring of COFINA debt, which reduced the face value of claims by 45% and secured debt payments by GDB cash flow from certain legacy assets without recourse to the Puerto Rico Government. This restructuring also eliminated approximately $1 billion in guaranty claims against the Puerto Rico Government.

The FOMB has also filed a proposed Plan of Adjustment to restructure more than $10 billion of debt and other claims against the Puerto Rico Electric Power Authority (PREPA) with the U.S. District Court for the District of Puerto Rico.

Here are some key statistics on the debt restructuring process:

The oversight board will be terminated once Puerto Rico has access to credit at reasonable rates and has achieved four consecutive years of balanced budgets. According to John Ceffalio, the wording of this section is vague, making it difficult to determine when the board will be disbanded.

PROMESA was successful in achieving its goals, according to the panelists. The plan crafted by the FOMB has reduced Puerto Rico's debt service payments and provided a clear path for the Commonwealth to achieve fiscal sustainability. However, Sergio Marxuach cautioned that while the debt limits were a temporary success, they will eventually expire, and the Commonwealth's budgeting process still needs reform.

Between 2007 and 2017, Puerto Rico's gross national income declined by 14 percent. This significant drop was largely due to the economic recession brought on by the repeal of the Section 936 corporate tax exemptions.

The economic downturn had a devastating impact on the island's population, with 46 percent living below the federal poverty line in 2015. This is a stark contrast to the U.S. national average of 15 percent.

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Puerto Rico experienced a sharp economic downturn due to the repeal of the Section 936 corporate tax exemptions and the Great Recession.

Between 2007 and 2017, Puerto Rico's gross national income declined by 14 percent.

In 2015, a staggering 46 percent of the population in Puerto Rico lived below the federal poverty line, a stark contrast to the U.S. national average of 15 percent.

This economic hardship had a lasting impact on the island's residents, with many struggling to make ends meet.

The local market in Puerto Rico is heavily burdened, with around $30 billion of the island's outstanding debt, roughly 42% of the total, being owned by residents. This is a staggering amount, especially considering the island's purchasing power parity per capita is only $16,300.

Local businesses and residents are the ones most affected by the government's cuts and increased taxes. Personal income taxes, corporate taxes, sales taxes, sin taxes, and taxes on insurance premiums have all been hiked or newly imposed.

Taxes on nearly everything and everyone have gone up, making life even tougher for the 41% of the population already living below the poverty line. The retirement age for teachers has been raised from as low as 47 to at least 55 for current teachers, and 62 for new teachers.

The legislative assembly and governor have taken steps to reduce operating deficits and reform pension systems, but it's a significant cost to bear for the local market.

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The US market was significantly affected by the downgrade of Puerto Rican bonds. Nearly 70% of US-based municipal bond funds owned Puerto Rican bonds or had some kind of exposure to Puerto Rico.

A notable cause for this tendency was the fact that Puerto Rican bonds are triple tax-exempt in all of the states, regardless of where the bond holder resides. This made them attractive investments for many.

Pre-emptive measures did slow down the damage of the downgrade's fallout, but investors were still warned that it would affect the municipal market in general. Concerns of a worst-case default scenario were already being considered.

Municipal bond funds that relied on specific debt had already experienced the backlash by the end of February 2014, leaving portfolio managers with fewer options in the market.

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Puerto Rico's financial status is complex and challenging. The island's bonds are not currently rated by major credit rating agencies, making it difficult for Puerto Rico to borrow on public markets.

One step to improve this situation is for Puerto Rico to have audited financial statements, which would help show that the government's budget is balanced. This could potentially lead to the bonds gaining wider traction on markets.

However, Puerto Rico's constitution needs to be revised to prevent the excessive debt that led to the crisis. The current interpretation of the phrase "available resources" includes the issuance of new debt, which has contributed to the island's financial woes.

Puerto Rico's debt is a complex issue, and one of the novel approaches used in its restructuring is the Contingent Value Instrument. This instrument links bondholder payouts to sales tax revenues, so if Puerto Rico's economy does better, bondholders will do better too.

The Puerto Rican pension system is structured differently than those in other prominent municipal bankruptcies, such as Detroit. This might make it harder to compare the situation to others.

Sales tax revenues in Puerto Rico are relatively stable and track the economy well. This is because they are "pretty precisely determined" and less susceptible to manipulation.

There is a precedent that was set in Detroit and some California bankruptcies, where pensioners tend to take smaller haircuts than bondholders. This might influence future negotiations in municipal bankruptcies.

It's difficult to forecast the outcome of the Puerto Rico debt restructuring process. Different classes of bondholders, taxpayers, and residents have competing interests that will be hard to reconcile.

There just isn't enough money to go around, as Matt Fabian, a municipal analyst, pointed out. The need to keep essential services functioning might make full repayment of bonds impossible.

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Puerto Rico's population is heavily reliant on federal social funding, with over 60% receiving Medicare or Medicaid services.

A significant portion of these individuals, about 40%, are enrolled in the Puerto Rican Medicaid program.

This disparity in federal funding has been a long-standing issue, dating back to 1968 when Congress placed a cap on Medicaid funding for US territories.

As a result, Puerto Rico receives significantly less federal funding for these programs compared to states like Mississippi, which has a similar population.

Mississippi receives a whopping $3.6 billion in federal funding each year, while Puerto Rico typically receives just $373 million.

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Puerto Rico needs audited financial statements to gain wider traction on public markets and potentially get its bonds rated by major credit rating agencies.

Having reliable, affordable energy is essential for economic growth, and increasing PREPA's reliability could reduce uncertainty in the eyes of rating agencies.

Puerto Rico's constitution needs to be revised to prevent excessive debt, as the current interpretation of "available resources" includes the issuance of debt.

Having audited financial statements would be a big step towards improving Puerto Rico's fiscal position, but it's just one part of the solution.

The government and oversight board are working towards increasing system reliability by bringing in private operators, which could help improve PREPA's finances.

Puerto Rico's budget needs to be definitively balanced to show that the government's expenses don't exceed available resources, and audited financial statements would help achieve this.