Is Puerto Rico Too Big To Fail?

Puerto Rico, a US territory, is teetering on the edge of financial collapse.

The Island’s plight is reminiscent of the 2008 collapse of Lehman Brothers, whose bankruptcy filing led US regulators to examine similar banks who were considered “too big to fail.”

Unlike Lehman or the City of Detroit, which just filed for bankruptcy, Puerto Rico, like the 50 states, cannot go bankrupt. But that doesn’t mean it won’t default on its $70 billion in municipal debt, which would be potentially ruinous for Mom and Pop investors. Three out of four municipal bond mutual funds currently hold Puerto Rican paper, which have been considered attractive because of their high yields due to Puerto Rico’s exemption from federal, state and local taxes, according to an article over the weekend in the Washington Post.

An Obama financial “swat team” has descended on the Island, according to the Post’s Michael Fletcher. But to what avail?

Unemployment there is skyrocketing, taxes have soared, workers are fleeing for the mainland for jobs, and the governor promises that “Puerto Rico will not default” on its debt.

As Fletcher reported: “The brutal combination of a long recession, a shrinking population and overwhelming debt has left Puerto Rico’s political leaders struggling to manage a conundrum: How do they tame at least $70 billion in debt while marshaling the resources to grow a shrinking economy and battle corrosive social problems, including a homicide rate that is nearly six times the U.S. average?

The crisis has left Puerto Rican Gov. Alejandro Javier Garcia Padilla juggling competing demands for budget cuts and other types of austerity demanded by Wall Street rating agencies, and the incentives and other spending needed to ignite growth.

‘Sometimes, you are between the wall and sword,’ Padilla said in an interview.”

The Center for a New Economy succinctly stated that Puerto Rico has been paying “daily expenses with (a) credit card” and has “borrowed just to keep the lights on,” according to the Post article, one of the most comprehensive to date on the extent of Puerto Rico’s financial problems and the risk for municipal bond investors.

A bailout by the US Government seems politically unlikely.

The Post article highlighted the extraordinary situation facing Puerto Rico and investors in its municipal securities: “But it remains to be seen whether the government’s actions will be enough to stave off the crisis. Earlier this month, the rating agency Fitch warned that Puerto Rico’s general obligation bonds could be downgraded to junk status next summer because of concerns that the commonwealth would be unable to return to the market anytime soon to borrow more at a reasonable cost.

Another downgrade would be a severe blow for Puerto Rico, effectively cutting it off from the market and paralyzing its efforts to dig out from under its mountain of debt.

If that happens, Lamba-Nieves, the director of the Center for a New Economy, said the federal government could feel pressure to step in with some type of bailout. “Puerto Rico might be a little too big to fail,” he said.

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