Puerto Rico Defaults


Tuesday August 4th, 2015   •   Posted by Craig Eyermann at 8:12am PDT   •  

US-bankruptcy-court-puerto-rico-seal The clock ticking toward Puerto Rico’s default on its debt has finally struck. CNN reports that the U.S. territory just went into default for the first time in its history:

The commonwealth paid a mere $628,000 toward a $58 million debt bill due Monday to creditors of its Public Finance Corporation. This will hurt the island’s residents, not Wall Street. The debt is mostly owned by ordinary Puerto Ricans through credit unions.

“This was a decision that reflects the serious concerns about the Commonwealth’s liquidity in combination with the balance of obligations to our creditors and the equally important obligations to the people of Puerto Rico,” Puerto Rico’s Government Development Bank president Melba Acosta Febo said in a statement.

The default is a historic moment in Puerto Rico’s economic “death spiral,” a term the island’s governor, Alejandro Garcia Padilla, has used. The island is struggling with about $70 billion in total outstanding debt, and its economy is in recession....

On Monday, Puerto Rico had to make a monthly debt payment of $483 million. Puerto Rico paid all its debt due except the $58 million due to creditors of its Public Finance Corporation. The government is strategically choosing not to pay the PFC debt because the entities that own the debt, credit unions and ordinary Puerto Ricans, have little legal power to fight back in court.

What is happening now in Puerto Rico, as it stiffs the lenders to whom it owes money, is particularly instructive, because it provides insights into how U.S. officials in other jurisdictions would prioritize who gets paid when a debt payment is due and who doesn’t.

In this case, Puerto Rico’s government has chosen to default on some 20 “moral obligation” bonds, which provide the least amount of legal recourse for those who lent the troubled territory money. In this case, that means stiffing the ordinary citizens of the U.S. territory whose financial institutions invested money in the bonds issued by the Puerto Rico’s government. The New York Times describes where the money went and how it was able to rack up so much more debt than it should ever have been allowed to take on:

While Puerto Rico made some other bond payments that were due on Monday, attention in the financial markets was focused on the decision to skip the $58 million in payments due on about 20 so-called moral obligation bonds. Those bonds were issued by a subsidiary of the Government Development Bank for a variety of projects—including school construction and the creation of landfills.

The government bank initially financed the projects, then refinanced them through its subsidiary, the Public Finance Corporation. By tapping the municipal bond market in that way, the bank removed the liabilities from its own balance sheet.

Although this particular type of bond does not carry with it a legal requirement for repayment in the absence of a budget appropriation, market experts said Puerto Rico’s decision not to pay amounted to a default and left them perplexed about the strategy of paying some bonds while letting others lapse.

By taking the actions it did to transfer its liabilities off of its balance sheet, Puerto Rico’s Government Development Bank arguably was committing an act of fraud by making it appear that both it and Puerto Rico’s government were more solvent than they really were. In doing so, they enticed the financial institutions in which ordinary Puerto Ricans entrust their savings, into buying the bonds that they have now defaulted upon.

And in defaulting, they’ve effectively seized the savings of ordinary Puerto Ricans. Not only won’t they receive the interest payments they were due, but they very likely won’t recover their principal.

Unless something changes, that’s the American playbook for government debt defaults.




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