Puerto Rico is in serious trouble.
The economy has been in and out of recession, and at 13.5%, its unemployment rate is painfully high.
Last week, The Economist compared the island’s economic crisis to the situation to Greece as the country undergoes further rounds of austerity.
Puerto Rico’s story is an important one, and it matters more than many Americans can appreciate.
We answer the seven basic questions you might have about Puerto Rico:
1) A lot of the U.S. states are in the dumps economically, so why are we now talking about Puerto Rico?
It’s recently become very expensive for Puerto Rico to borrow money. Puerto Rico’s bonds are trading at about 60 cents on the dollar, and yields have climbed above 9%, according to Reuters. They’re rated just above investment grade with a negative outlook.
This is much higher than what the states face.
That’s never good, but it’s really bad for Puerto Rico, which is unusually dependent on deficit financing, meaning borrowing money to pay the bills.
Because the island’s securities are tax exempt, bond investors around the world and especially in the U.S. have for years catered to the island’s debt financing habit.
2) Does this mean Puerto Rico is the next Detroit?
In a way. People are now saying Puerto Rico could default.
However, unlike Detroit, it cannot file for Chapter 9 municipal bankruptcy protection — the law treats it like a U.S. state.
So the specter of a federal bailout is now being raised.
3) Seriously? A bailout?
Seriously. Puerto Rico’s banks already received bailout funds 2010. Only last week was Banco Popular, the island’s largest financial institution, able to ask the Fed whether it was eligible to exit TARP.
The island itself was in talks to get a bailout in 2009.
4) How did everything go so wrong?
The Puerto Rican economy has been in and out of recession since 2006, when an earlier fiscal crunch caused San Juan to shut down (yup, they’re an American territory alright). That was also the same year federal tax breaks for an experiment designed to pump up the island’s manufacturing sector expired.
But the island has never been terribly competitive. The island’s labour force participation hovers around 40%, and the public sector accounts for 20% of all employment.
The Great Recession did not help matters. Three Puerto Rican banks went under as the world’s travellers couldn’t afford to vacation to the island nation.
Everything came to a head this summer as unemployment hit a 2-year high and an index measuring Puerto Rican economic activity shrank 5.4% in August, the biggest drop since 2010, Bloomberg’s Michelle Kaske says.
That helped send bond yields spiking to record highs, triggering the current crisis.
Maybe. But if you live in the United States, the chances that you or someone you know have pensions exposed to Puerto Rican debt.
As we mentioned, Puerto Rico’s tax-exempt bonds have (until now) been very popular with U.S. muni funds: about three-quarters of them hold Puerto Rican securities.
And we don’t even know the extent of the exposure within those funds: Bond Buyer reported last week the SEC was checking around to see copies of many muni funds’ most recent stress tests.
So if Puerto Rico is unable to meet its obligations, it’s likely you or someone you know is going to lose money.
Muni funds have already had their worst year ever, in part because of the Puerto Rican situation.
6) You now have my attention. What is the government doing about it?
For now, Washington says it is “monitoring the situation.”
In Puerto Rico itself, there have been successive administrations who have attempted to cut and tax the island out of default danger.
Current Governor Alejandro García Padilla has successfully passed legislation that includes reinstating higher corporate tax rates, and imposing a new gross receipts tax.
He also raised the retirement age for state workers, upped pension contributions, and cut summer and Christmas bonuses.
That’s actually a lot more than what some other states facing pensions crises, like Illinois, have done…
7) Ok, so if I want to keep following this story, what should I look out for?
Unfortunately, Puerto Rico does not have an economic engine like Chicago to keep it afloat.
So, now we have to wait and see if the island can stomach austerity socially and economically.
And there are already signs it is struggling to do so: in the past few years, tens of thousands of people have left the island for better opportunities, mostly coming to the U.S.
We reported yesterday how the most recent round of cuts has caused a spike in theft of school property. Some have also blamed a recent, deadly bacterial outbreak at a public hospital on lack of necessary funds.
García Padilla administration members have been aggressively making their case to investors and business leaders stateside — just this last week, the country’s economic development minister came to New York to meet with executives at places like BlackRock and Pfizer — that its fiscal reforms are on track.
If you see any cracks emerge on this united front, you’ll know the worst has only just begun.