What’s surrounded by water but has no liquidity?
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Yesterday in forgone conclusions: S&P downgraded Puerto Rico’s debt rating to junk status to (BBB-) (BB+). As Bloomberg notes, yields on Puerto Rico’s debt had been trading at junk levels since September.
What Puerto Rico is struggling with, in S&P’s words, is liquidity; the agency noted that the island doesn’t have affordable access to the debt markets. On Monday, the WSJ reported that Puerto Rico is considering a $2 billion debt offering at rates of 10%, which is “more than twice its yields on 10-year debt a year ago.” Puerto Rico’s 10-year general obligation bonds are yielding 9.92%, per Thomson Reuters data.
Faced with $70 billion in debt, Puerto Rico may have no other choice. “After balking at what they perceived as usurious rates back in the fall, PR officials appear to have resigned themselves to paying whatever it takes to get a financing done,” Triet Nguyen writes.
How did Puerto Rico get here? “Even as the island’s population shrank and the economy contracted 16% since 2004, the government kept selling enough bonds to saddle each man, woman and child with $19,000 in debt,” Bloomberg wrote in October. That Puerto Rico’s debt has high yields and is exempt from Federal, state, and local taxes has helped — some 77% of muni funds own Puerto Rican bonds. Cate Long calls the island’s bonds the most widely held junk bond in muni finance; Matt Zeitlin has more on those funds here.
With unemployment at 15%, the island is also experiencing what Arian Campos-Flores called a historic exodus, including a “a net loss of 54,000 migrants a year in 2011 and 2012 on an island of just over 3.6 million people”. In a nice explainer on the downgrade, Nuveen Asset Management notes that you can count out a formal US bailout or a Chapter 9 bankruptcy — the former is unlikely and the latter wouldn’t be legal under US law.
What’s already happening, according to Martin Sullivan of the Tax Analysts blog, is a backdoor bailout by the American government. In 2010, the island passed an excise tax on US companies that manufactured in Puerto Rico. But those companies were able to simply deduct taxes paid in Puerto Rico, technically a foreign jurisdiction, from their US tax bills. “In effect, the new tax would be paid by the US treasury, not US companies,” Sullivan says.
“In other words, the American government moves tax revenue away from its own coffers and towards Puerto Rico’s, through the transmission mechanism of USA, Inc.,” The Economist writes. “The only ones on the short end of the stick are U.S. taxpayers, who are footing the bill that they would probably be unwilling to pay if they were ever asked,” Sullivan says. — Ryan McCarthy
On to today’s links: