An open letter to Puerto Rico Governor Fortuño
Dear Governor Fortuño:
I wanted to write you to discuss the condition of Puerto Rico’s economy and its municipal debt load. After I wrote a column last week entitled “Puerto Rico is America’s Greece,” I was surprised to see the piece get a lot of attention. What I said has been common knowledge in the U.S. bond market for some time, and the facts that I brought up have been previously pointed out by the major credit rating agencies. For those in municipal bond markets, I wasn’t really adding much that was new to the conversation.
But it turned out the attention my piece was getting was from people outside the bond market. Those who were responding to it were those who love Puerto Rico and are concerned about its future, namely its citizens. They seized on what I wrote and passed it around on Facebook. Newspapers like elnuevodia.com and blogs picked it up and debated the fine points of the island’s unemployment rate and deficit spending. I’ve never seen anything like it in the United States.
Now, before going any further I need to mention that I made one mistake in that piece, which I did not discover until I read the rating agencies’ reports about the commonwealth. Your constitution requires that bond principal and interest be repaid before your government can make any other expenditures. That means bond repayments take precedence over payments for education, healthcare, government-worker wages and pensions. Bond markets cheer for this, of course, but I’m not sure that your citizens are entirely aware of it. Michael Corkery of the Wall Street Journal also wrote about your bond offering last week and didn’t mention the seniority of payments that makes your debt so appealing to investors.
Aside from that error, I stand by everything I wrote in my earlier post. If you don’t want to take my word for it, take a look at what the rating agencies have to say. They are typically pretty blunt in their assessment of the fiscal condition of states and municipalities. Here is what Moody’s said about your recent debt offering in a report on Mar. 6 (emphasis mine):
The commonwealth’s general obligation bond rating (Baa1) has been pressured by continued financial deterioration of the severely underfunded retirement systems and weak finances, with a historical trend of funding budget gaps with borrowing. Furthermore,while the administration has taken steps to control spending and move toward structural budgetary balance, needed retirement system reforms and the increasingly heavy debt load could exacerbate strains on the commonwealth’s economy and budgetary finances in the coming years.
The debt service payments were initially made with advances from the Government Development Bank and bond proceeds will be used to repay those advances. This is essentially deficit financing and follows the $600 million deficit financing in fiscal 2011.
Here is Fitch’s take on the latest financing, from a note dated Mar. 5 :
HIGH DEBT LEVELS: Debt levels are very high, partially reflecting the consolidated nature of the central government’s role, and have increased as the commonwealth has used deficit financing as part of its fiscal stabilization plan.
And on Mar. 8, Standard & Poor’s said this:
In our opinion, the practical and political ability of the administration to rely exclusively on expenditure cuts to balance the budget in fiscal 2013 is relatively limited, given the depth of the cuts already adopted, and the potential for additional expenditure reductions to hamper what remains a relatively anemic economic growth.
Many governments use deficit financing, although this is rare among U.S. state and local governments due to constitutional limitations. Deficit financing works when an economy is growing and can service higher debt loads in the future. But Puerto Rico is barely growing as islanders move to the mainland and unemployment is stuck at very high levels. Critically, the government has only saved enough funds to pay approximately 9 percent of pensions (page 184) that will be due in the future, unless substantial contributions from your overstretched budget are diverted there.
The unemployment situation is the pivot point on which all your economic activity turns. Here is a 10-year chart on Puerto Rico’s employment figures from the Bureau of Labor Statistics; it looks bleak for people needing jobs in your commonwealth:
You have raised taxes to bring in more revenue, and you have reduced the size of the government. I’ve studied what Juan Carlos Pavía, the director of Puerto Rico’s Office of Management and Budget, has done to rationalize and get better control of government cash flows. These are all useful and positive actions. But it still comes down to the need for your economy to grow to support your increasing debt load. Instead, the numbers show the economy is barely growing. I’ve read in many places about a large shadow economy, but it’s hard to collect tax revenues to support bond payments from economic activity that happens outside the official sector.
Governor Fortuño, I could go on all day citing rating agencies and U.S. fund managers who do not own the debt of Puerto Rico and will not because of the instability of the fiscal trajectory. But you have already lost this war when your cronies attack me and call me names rather than engaging in dialogue on these complex issues. I’m not the enemy, Governor Fortuño. I’m like the child watching the parade who says: “Look! The emperor has no clothes.” And it’s clear to many that the emperor indeed has no clothes.