EspañolIn March of this year, Puerto Rico Governor Alejandro García Padilla delivered his State of the Commonwealth speech, promising a balanced budget and no more borrowing. At first glance this sounded like a bold step. With some US$70 billion in debt, Puerto Rico has been financing budget deficits for decades under the leadership of both major political parties.
Something about the announcement, however, didn’t quite add up. That’s not to say balancing the budget and putting an end to borrowing is a bad thing; it is exactly the right thing to do. So what is wrong with this picture?
Earlier this year the commonwealth issued about $3.5 billion in bonds as a form of gap financing to help the government meet its obligations for the next few years as the economy recovered. Controlling spending and boosting the local economy are part of that overall plan to get the island back to some semblance of economic sanity.
While the objective is good, there is one question unanswered: is the island really going to balance the budget with no new borrowing, or did they just balance it with $3.5 billion in bonds so they could say they won’t borrow money next year?
Now comes a report that the commonwealth will issue another $500 million in bonds next year.
Wait … what?
If Puerto Rico issued $3.5 billion for gap funding to get over the borrowing hump, why do they need an extra $500 million next year? In fairness, the new bond issue is being sold as a way to refinance some municipal debt; however, it is also expected to help finance new public projects. In other words it is, at least in part, financing deficit spending.
I’m not the only one doubting the promise of no more borrowing, and there is already backlash over earlier bonds and losses. Reuters “Muniland,” for example, remains bearish on Puerto Rico. Referencing Jim Grant of Grant’s Interest Rate Observer, they write that “given the commonwealth’s population decline and low labor participation rate of around 40 percent, he is unable to discern any long-term plan to right size the government’s debt load.” Meanwhile, some investors are suing UBS over risky PR bond funds.
The governor’s insistence that Puerto Rico is not Detroit or Greece are of little comfort when one considers the double talk on balanced budgets and debt sales. Pessimism continues to reign supreme in the non-political circles, as exemplified by this article in GuruFocus.
Meanwhile, Doral Financial announced that they will be revising their capital plan. Under orders from the FDIC, the troubled PR bank may no longer include some of or all the tax receivables from the government of Puerto Rico in its calculation of its Tier 1 capital. That money represented nearly half of the bank’s Tier 1 capital. The report says of the decision: “[leaves] Doral out of compliance with its Consent Order with FDIC because it will no longer be able to accept or roll over brokered deposits, which means they could lose about 18 percent of their deposit base.”
Doral Financial’s woes are the tip of the Puerto Rico economic-disaster iceberg. Gurufocus.com notes that Doral’s financial difficulties could spread to other banks on the island, and some of those other banks are already in trouble.
Doral maintains that the tax receivables could be included properly in the revised plan and is working with the FDIC to do so, while also seeking to raise capital and consider the sale of some assets. Beyond what is appropriate or not within the interminable maze of government banking regulation, is it possible that the FDIC knows something about potential future tax receivables revenue that the Puerto Rico government isn’t saying? If long term tax revenue is in doubt, how will Puerto Rico maintain its promise of a balanced budget? It can’t.
The islands economy continues to shrink although the pace has slowed. The island’s economy shrank at an annual rate of 0.8 percent in March, compared to 2.5 percent in the previous month. However, the economy had an accumulated drop of 3.4 percent from July 2013 to March 2014.
Still, there are those who see a brighter future for the island. Billionaire John Paulson plans to invest a billion dollars betting on the island’s recovery. Paulson’s optimism, however, appears wrongly placed given the financial situation in the United States. Puerto Rico is not (as they say) an island unto itself, when it comes to its economic future. As a US territory it goes where United States goes, which is nowhere fast. Newly appointed Chair of the Federal Reserve Janet Yellen says “under current politics the federal government’s deficits will rise to unsustainable levels.” The United States will add another $7.5 trillion in new debt in the next six years.
In addition, in what may at first glance be a good story, the US unemployment rate fell to 6.3 percent as the economy gained about 288,000 new jobs. Once again, however, the devil is in the details. The number actually fell because people who have stopped or given up looking for a job are no longer counted. The number of people who gave up rose sharply, 800,000 last month alone. A staggering 92 million US Americans are not working.
So what happens to the United States and by default Puerto Rico when those debts and all of that unemployment come home to roost in the form of an economic downturn of biblical proportions?
If there is any bright spot in the future of Puerto Rico’s economy, it is that things are so bad that the legislature is finally putting all options on the table. Included in those options are the legalization of marijuana and prostitution, two Ideas I have long advocated.
Author’s note: a summary of the Governor’s budget proposal may be found here.