Inside the Billion-Dollar Battle for Puerto Rico's Future - The New York Times

Inside the Billion-Dollar Battle for Puerto Rico's Future - The New York Times

Link to Article

I wanted to share the above named article from the December 19, 2015 edition of the New York Times. It provides a great background and overview of events leading up to the current situation. Insight into the political and financial landscape is explained in an easy to understand way. The article  effectively explains the "sides" to each argument. Although they seem clear, they are indeed ambiguous.

Total Debt: 70 Billion USD maturing over 5-10 years

Party 1 - Debtors (Puerto Rican Government (65% of debt, PR Power Authority (35% of debt))
Party 2 - Lenders (20% Puerto Rican; 35% Hedge Funds; 45% Bondholders)
Party 3 - The US Federal Government

What do lenders want?
To get paid. This is the only possible solution for them. They aren't even willing to take a haircut on the debt owed. They will go to any extent to ensure they get what they want. Political contributions, lobbying efforts, will all protest a bailout or debt restructuring of any kind. Even a deal where the Power Authority was allowed to declare bankruptcy (or restructure debt) in an effort to restructure debt (33%) was strongly lobbied against by the holders of that specific debt. The deal would have cost US taxpayers nothing yet it was not even considered. Marco Rubio, for example, is stuck in the middle of a Tea Party base and a Puerto Rican constituency that helped elect him to Senate in Florida.  A supporter of relief for Puerto Rico 6 months ago, Rubio has since backed away from sponsoring a relief bill and now says a "bailout" should be a last resort. Just the fact they are calling it a "bailout" and not "debt restructuring" (like many companies engage in on a regular basis) shows the power of politics.

What do debtors want?
They want to pay the debt but they can't. If they can't pay they want someone to give them the money (bailout) or they want debt restructuring (loan forgiveness). They know they can't pay so they are just waiting for situation to necessitate relief described in the previous sentence. They are also hiring lobbyists of their own to promote a bailout.

What does the US Federal Government want?
They promote stability. They know the debtors can't pay and the lenders will have no mercy. They won't approve a bailout because the lobbyists have done their job with the Republican led Congress. Obama can't successfully pass special Chapter 9 bankruptcy protection for US Territories in a Republican Congress. They don't want a humanitarian crisis to take place on an island where 40% live in poverty so they offer a bandaid in the form of $3 Billion USD if the island submits to financial oversight.

La Perla (North Corner) October 2014

Kicking The Can Down the Road

The Governor of Puerto Rico recently announced a $16 Billion gap over the next 5 years (up from $14B previously forecasted). Furthermore, the gap has been extended from 5 to 10 years. The committee assembled to balance the budget and draft an economic recovery plan (in collaboration with the General Obligation committees) have not been able to accurately realize the true nature of the economic disaster since its inception. Any plan or budget will be futile as the Island only faces an uphill battle with an exodus of the working class and shrinking tax base. These are mere gestures to try to please bondholders (2 have recently filed suit against the Island).

In the last weeks of 2015, Democratic members of Congress tried to persuade members to include bankruptcy protection for the island in a year end spending bill. Speaker Paul Ryan has called for a "responsible" solution by March of 2016. The language was not included and the bill barely passed due to Democratic (and some rebel Republican) pushback.

The Island is using clawback measures to desperately try to meet obligations. Instead of income tax returns, the Island is issuing IOUs. Residents can use tax return credits to pay other municipal fines, fees, and bills. For example, a resident won't get a tax return but they can pay a parking or speeding ticket with funds they should have received.

So the questions remains, who is responsible? Well, everyone is responsible. The banks are responsible, the bondholders are responsible, and the Island lawmakers are responsible. In any agreement there are obligations and each party has risk. Bondholders and lawmakers on both sides (US and Puerto Rico) failed to adequately calculate risk. This seems to be more prevalent in recent times. The only difference is that Puerto Rico doesn't have a golden parachute (i.e. bankruptcy protection or the ability to print money). Should they have protection? This writer thinks YES but that is to be determined. How can other municipalities within the US declare bankruptcy and go on about their daily lives.

At the very least the Puerto Rican people are LEAST responsible because they after all didn't have any say in their territory status (yes it was voted on about 70+ years ago but only after the issue was forced onto the Island). Corruption and an inefficient government have plagued the Island for as long as anyone can remember. Taxes, fuel, and energy prices, unemployment, and the shrinking middle class have plagued the island. The pharmaceutical tax incentives of the 1990s and the recent Act 20/20 legislation are good attempts to draw outside investment but they are also not enough to tackle the whole problem.

What we are witnessing now is just a game of back and forth, a dance, an exhibit of smoke and mirrors, awkward and puzzling actions to keep everyone wondering on the edge of their seats. There is no need to be anxious if you are living on the Island. It can only get better. It can't get worse. The US won't let it become a humanitarian crisis. Not on their watch. The money will come. Puerto Rico will be bailed out in one way or another. The likely source is long duration bonds to restructure debt and reduce obligations outstanding. A general restructure of debt will be necessary. Someone will have to take a haircut.

Islote, PR (near Arecibo) October 2014

Winners and Losers

The moment we have been waiting for us finally here. Puerto Rico has officially defaulted on part of its debt obligations. The island will still make payments to finance its general obligation fund but will not be able to fulfill other bond payment obligations.

The government and the markets are entering unchartered waters due to the unique nature of the island territory to the United States. Bondholders will be sitting on the edge of there seats waiting to see if they are the chosen few that will actually receive payment. This uncertainty will not have a positive impact on the markets. What will other US municipalities do? Detroit, Orange County, and other municipalities facing the same dilemmas now and in the past do not have the luxury to selectively make bond payments. The nature of credit markets is "all or none". Either you pay your bills or you don't. This is a very interesting case study. 

Institutional funds and other investors  will be left holding the bag at the whim of Puerto Rican legislators. Puerto Rico is actually the winner in this situation. How do you squeeze blood from a stone? You can't. Will Puerto Rico be able to borrow money? No. Will the US let one of its territories fall into a humanitarian crisis? Probably not.

Castillo San Felipe del Morro 2014

Common Sense Proposals

Finally! After months, US lawmakers have compromised to take a more rational approach to solving Puerto Ricos debt crisis. House Speaker Paul Ryan directed financial committees to take a common sense approach to preventing Puerto Rico from defaulting on January (or May) debt payments.

One approach will be allowing Puerto Ricans to qualify for the Earned Income Tax Credit currently available to citizens living in the States. This is a step in the right direction. Congress may not be able to legally allow the Island to default but they can even the laying field for its residents. Medicaid is another area where the government can help alleviate financial pressure.

Puerto Rico's position has not changed although policiticians are becoming more anxious that default is inevitable. There is no question about it. Puerto Rico will default. The impact on the people of the Island will be a directly proportional to the governments ability to toe the line of default to maximize negotiations between the municipalities and debt holders. 

Rising interest rates should also throw a wrench into the equation. Let's see what happens.

Palmas Del Mar (October 2014)

Where Are We Going?

We still don't know what the future holds for Puerto Rico. There have been numerous studies and articles describing the situation and desperate and possibly, as Forbes described, leading to a humanitarian crisis. We know what the problem is but what are the possible solutions. Remember the game of Battleship where you would call out your opponents position in an attempt to sink their ships? We can describe the situation between Puerto Rico and bond holders in his manner.

Goal = Balanced Budget

Possible Solutions:

1) Raise Revenue to balance budget

The government can raise revenue by increasing the amount of taxes collected. There are a variety of ways to do this but almost all will lead to an exodus of residents from the island. An eroding tax base will lead to an incurable problem. Raising taxes is not a long term solution to the problem.

2) The budget can be balanced by increasing revenues, reducing costs, and usually the combination of both. Cost cutting is the best way for Puerto Rico to balance the budget and pay bond holders. Since the government has already increased taxes, witnessed an erosion of tax base, they should cut costs to demonstrate government austerity and restore confidence to all involved. 

Governor Padilla has atleast taken a realistic approach that the debt cannot be paid and unless restructuring occurs there will not be a meeting of obligations. He had also increased taxes and reduced some government services in an effort to balance the budget.

Opportunities: Padilla had already ordered an end to marajuana related prosecutions stating it was costing the territory millions a year in administration. This can also be a revenue producer for the island should the laws become favorable to the medical marajuana industry. This kind of cost cutting is a good example of measures that can be taken. Any unnecessary cost should be cut if there is not a clear positive benefit.

If the territory makes an effort to increase economic efficiency then bond holders may be able to compromise. For example of the government shows austerity by changing the laws of the general obligation fund GOF to meet financial obligations they are showing a real desire to balance the budget.

Certain agencies are already facing pay freezes for the uncertain future. Given that the entry level salary is almost minimum wage and dramatically increases in years 2-4, this had a dramatic impact on the population. Unfortunately, this is a step in the right direction.

Palmas Del Mar (October 2014)

Puerto Rico Walks Away From Talks With Bondholders

Today, 21st of October, Puerto Rico walked away from the table with bond holders. That must be nice. We all knew this was bound to happen. It was a game of brinksmanship that had already been decided long ago. The only difference is the number of sunk ships was yet to be determined. The only reason both sides kept slow playing is because the bond holders wanted to lose the fewest ships.

So, what next? Well, I don't know. If Puerto Rico loses it's credit rating, they have no ability to borrow money and restructure debt. They also have no incentive to pay back debt since it's so insurmountable it would be like putting out a forest fire with a single bucket. The next thing that is likely is a series of judgements which should prove interesting given the jurisdiction of the island and the mainland.

But as always, I see an opportunity to buy real estate. Why not? The value is intrinsic to the value of the land itself. The land sells itself. Those looking for good long term investments should still consider buying land and holding for a horizon no less than 20 years. There are many hot spots around the island. Anything close to the close will be hard to mess up.

Palmas Del Mar (October 2014)

The Good, The Bad, and The Ugly

Let's start off with The Ugly.

The current drought and water rationing scenario in Puerto Rico demonstrates a lack of planning and foresight by those in charge. With only a 3 month supply of water in reserve, many municipalities are left with water 1/3 days. Of course, in the tourist areas, this policy doesn't apply. 

The sad part is that with a little capital investment, the whole problem could be avoided. Yes, the carribean is experiencing its worst hurricane and rainfall drought in 9 years, but that doesn't excuse the island from only capturing 20% of rainwater. International reports indicate a strategically placed dam would alleviate the island of its water shortage problem. The project would cost upwards of 350 MM USD and obviously PR lacks the fuss to engage such a capital intensive project.

The Bad

It's official. Moodys has downgraded the island and labeled them as default on their obligations. Now what? More people are going to leave for th mainland. The tax base will continue to erode. The underground economy will continue to grow as a result of fewer industry level jobs. The government will be in a worse position to negotiate debt. The only answer is foreign direct investment, whether it be mainland US or elsewhere.

The Good

Tourism. Luckily the island is still flush with tourists. Real estate opportunities are increasing as people have to leave their homes and move to where the jobs are. Acquiring a distressed asset in Condado is my best bet. You can always rent it out to tourists of the rest of th island is a ghost town.