Money Can’t Solve Everything: A Puerto Rican Intervention

Money Can’t Solve Everything:  A Puerto Rican Intervention

        Puerto Rico’s reactive, short-sighted fiscal management has placed the U.S. territory in a serious predicament.  The Caribbean island has been operating like the Federal Reserve of the United States, without the resources; Puerto Rican decision makers continually issued debt financing with a false pretense that they were securely backed.  Or at least would be bailed out by the world economic power that is the United States.  The global economy will shatter if the continental United States collapses financially, but the collapse of a little island territory with only .17% of the world’s GDP1 does not warrant the same international call to action to bail them out.  Puerto Ricans are sliding down this financial slippery slope due to poor debt financing strategy, and should resolve their mismanagement without a bailout.  

        A debt payment is a financial transaction in which a consumer purchases a promissory note from an entity with the expectation of reimbursement with interest after an allotted period of time.  The entity, or country in this case, receives the money up front from the consumer in order to invest it in business or municipality developments.  In theory, these investments will create enough wealth to pay back the original investment easily.  

        However, there is the possibility of the entity missing its debt payment.  If the debtor has insufficient funds when the note has come to maturity, then the buyer of the note does not receive their money back.  Bonds with more risk, typical of smaller corporations or municipalities, are more likely to default.  In some cases, these bonds may be backed by government tax-dollars and the government will step in to pay off the debt.

        These higher risk bonds, especially ones with promises of high return yields over a short period of time, are referred to as “junk bonds.”  Rating agencies, such as Moody’s and S&P, will rate these bonds with worse ratings, like a BBB, to signal the higher level of risk associated with these transactions.  Junk bonds played a crucial role in the Great Recession because many were issued in the Real Estate market and covered up with better ratings than they deserved.    

        Municipality bonds—like those Puerto Rico issued—are bonds issued by public entities in order to finance public projects like highway infrastructure or schools.  Municipal bonds are seen as less risky than many other bonds, but it depends entirely on the issuer.  Bonds from an impoverished city can actually be quite risky.  Government-issued Treasury 10-year bonds, on the contrary, are considered the gold standard in bonds.  Besides one quick blip in 19792, T-bills have not defaulted since the origination of the concept, making them virtually risk-free.  Therefore, municipal bonds have a bit more risk, and possible higher yields, associated with them.  

        In the case of the Puerto Rican debt crisis, many of these municipality bonds turned out to be risky ventures.  One severe problem that aided this debt was the government provided free electricity to municipalities and other government-owed ventures.  Businesses like water parks and baseball fields benefited from the free electricity, which led to the government incurring more debt.  This is one of the reasons for which Puerto Rico does not have the funds to pay back bondholders.

        So how should the rest of the world, primarily the United States, address this crisis?  The United States could either rush to the aid of the Puerto Rican government, or let them figure it out themselves.  There are levels to which the United States could intervene as well.  They could potentially give them Puerto Rican government a lump-sum bailout and allow them to dictate how to spend it.  Or United State officials could overtake the current government that has shown themselves to be inept in money management, and attempt to salvage the island with their own system.

...