Puerto Rico’s Inevitable Default

Puerto Rico

As I have said before, the impossible never happens, while the inevitable always does. And as Puerto Rico’s governor has said before, it is impossible for the island to repay its $72 billion in public debt.

So Puerto Rico’s default was inevitable

The commonwealth’s Government Development Bank failed to repay almost $400 million this week. Unless and until Congress gives Puerto Rico the ability to restructure, more defaults will follow. Lawmakers have been urged to act by parties as disparate as Treasury Secretary Jacob Lew and Lin-Manuel Miranda, the award-winning writer and star of the musical “Hamilton.” The Puerto Rican government has already made significant cuts to public services, but Gov. Alejandro Garcia Padilla has bluntly said that that there is simply no way it can meet its existing obligations.

The inevitability of Atlantic City’s default is equally clear, barring a state bailout that New Jersey Gov. Chris Christie and legislative Republicans are disinclined to provide. Or more accurately, they are disinclined unless the state takes over the city’s finances with the power to void union contracts and cut municipal payroll and services.

In the meantime, Atlantic City is “running on fumes,” according to Mayor Don Guardian. Though the city managed to avoid default last month by making a $1.8 million interest payment on 2012 municipal bonds, the city government turned out its pockets to do so. The municipality’s undiversified economy in combination with New Jersey’s unfavorable financial climate means conditions are unlikely to change any time soon. If Christie and the Republicans succeed in gaining financial control, maybe the city’s creditors will be paid in full and maybe not, but the overriding goal is to restore Atlantic City’s access to the financial markets to the greatest extent possible.

Not that financial markets seem to have any institutional memory or ability to learn from prior mistakes. Argentina is a serial defaulter that stiffed creditors around the world less than two decades ago. A few creditors held out and fought a protracted legal battle on two continents. Even after they won, the previous Argentine government refused to honor its debts. Three years ago, the International Monetary Fund took the unusual measure of censuring Argentina for claiming inflation was lower than it really was in order to avoid paying the full interest due on some of its obligations. While the country took the steps necessary to avoid being expelled from the IMF altogether, many analysts remained dubious about its economic data and its overall trustworthiness.

The new Argentine government under President Mauricio Macri has been willing to finally pay the country’s debts – but only by going back to the credit markets again. So now we have new creditors, who just bought $16.5 billion of the country’s bonds (and subscribed for over $68 billion, had Argentina been willing to sell that much), thereby providing the funds to pay off the country’s old creditors. This, like a couple that remarries after divorcing, is clearly a triumph of hope over experience.

Then there is the Chicago school system, whose financial condition might best be described as hopeless. Chicago’s schools have struggled for decades, their problems mitigated for short periods by heavy borrowing from the system’s pension fund and elsewhere. Now owing more than $9 billion to its pension plans and $6 billion to bondholders, the system wants help from the state of Illinois.

Unfortunately, the state of Illinois has the nation’s worst state-level credit rating and remains enmeshed in its own budget logjam. As with many of other places that run up against impossible problems, ongoing public employee pension funding issues constitute a large part of the state’s woes, but they are not the only concern. Its university system is also strapped for funds. One campus – Chicago State University – laid off about one-third of its staff this week.

Get used to such stories. Government financial problems like these are neither ubiquitous nor as extreme as what we see in Puerto Rico, Atlantic City, Illinois and previously in Detroit. But they are reasonably common, and in many places they are getting worse. The universal factor in all of these situations is that governments make promises and provide services for which they lack the means to pay, and they make up the shortfall by borrowing as much as they can for as long as they can. Finally, when they can borrow no longer, they collapse – just like every Ponzi scheme ever.

Such schemes, which rely on an endless supply of new victims, must inevitably fail because the supply of victims is not actually endless. And neither is the supply of witless lenders willing to provide more funds to insolvent borrowers to enable them to pay past debts – although Argentina’s success in rounding up new money does force me to acknowledge that the pool of amnesiac investors is a lot deeper than I would expect.

Impossible promises are never fulfilled. Inevitable defaults always occur. Puerto Rico’s missed payment this week is far from the worst and far from the last we are going to see.

About Larry M. Elkin 553 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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