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The High Cost of Government Not Paying Debts

Thursday June 29th, 2017   •   Posted by Craig Eyermann at 6:19am PDT   •  

37867592 - surprised woman shocked to see the bill As Illinois’ debt doomsday clock keeps ticking down to July 1, 2017, where in the absence of the state legislature passing a budget that can be approved by the state’s governor, the state government will almost certainly have its credit rating cut to junk status as it will also stop paying contractors to work on road projects throughout the state, it is important to consider what is going on in the U.S. territory of Puerto Rico, which has not only had its credit rating cut to below junk status, it is currently going through the state government-equivalent of bankruptcy proceedings for restructuring its debts.

Writing in Investor’s Business Daily, Illinois resident Ike Brannon describes how the actions being taken by the U.S. territory’s political leaders are directly and negatively impacting Illinois’ own dismal fiscal situation.

Puerto Rico is currently $73 billion in debt, which is close to 100% of the island’s annual output. It owes a sizeable portion of this to the island’s current and future pensioners: Puerto Rico’s pension fund is woefully underfunded. It also owes billions to general obligation bondholders — whose investments are guaranteed by the island’s constitution — and to COFINA (also known as Puerto Rico Sales Tax Financing Corp.) bondholders, who hold debt explicitly backed by sales-tax revenues.

The government wants to greatly reduce its payments to these creditors — and others — in order to avoid further spending reductions and to minimize necessary reductions in pension benefits, among other priorities. While such actions may appear to be a reasonable and fair outcome, the reality is that setting aside established law and precedent has long-term ramifications that go beyond Puerto Rico.

This is problematic because there are numerous other states — my home state of Illinois comes to mind — that are also in dire financial straits. The Prairie State has been effectively running a deficit for at least a decade and is burdened by a public pension that will likely go bust the next time there is a recession.

Illinois also has taken a page out of the Puerto Rico playbook by beginning to demonize its bondholders as greedy investment bankers profiting off the misery of others.

While such rhetoric plays well with the voters — and that is to whom Puerto Rico’s new governor, Ricardo Rossello, is clearly playing — it makes escaping the island’s financial predicaments more problematic. Once the Puerto Rican government and its oversight committee reach some sort of arrangement for moving the island forward, it will need to re-engage with capital markets to borrow money — whether it be for capital improvements, short-term credit arrangements, or something else.

If Puerto Rico spends the next year denigrating its lenders and trying to break contracts, few investors will want to take a chance lending money to the island again. Put simply, the market cannot credibly believe future repayment promises no matter what steps Puerto Rico takes — at least not until it returns to economic expansion and solvency.

What’s more, if Puerto Rico successfully breaks these covenants, municipal bondholders in Illinois — and elsewhere — are going to perceive that their investments now contain much more risk than they had previously perceived, and will demand a higher interest rate to take it.

In short, Puerto Rico’s shenanigans may hasten Illinois’ insolvency.

The key to regaining solvency is to reverse the overspending commitments of politicians that created the debt problems for each in the first place.

You would think that politicians everywhere would be anxious to send the message to the bad actors among their numbers to stop the bad behavior that is only hurting their ambitions. But that’s the problem of being in the business of taxing the money made by the people who earned it and wastefully spending it to advance their political agendas – they just don’t feel the pain until it is far too late. And when they do, the politicians waste everybody’s time in slurring the people who were willing to keep them afloat in good faith and by demanding that responsible taxpayers bail them out for their avoidable predicaments.

The very least that they could do is not act surprised when the bills for their bad behavior come due.

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June 2017