posted on 03 May 2016
by Michael Haltman
Yesterday, May 2, the Puerto Rico Government Development Bank defaulted on approximately $422 million in debt payments!
Long in fiscal disarray, this missed payment by Puerto Rico was merely the opening salvo in the Island's debt crisis as over the summer approximately $2 billion more is going to be coming due.
Consider for a moment why this default is so concerning for a multitude of American investors and not only for the people of Puerto Rico who are personally and physically entangled in the crisis.
If my memory as a former municipal bond analyst serves me (albeit back to a time when information was stored on microfiche and communication was accomplished using faxes on heavy paper), the bonds of Puerto Rico issuers are triple-tax exempt for U.S. investors.
What this means is that if an investor in a high-tax state like New York, California or Massachusetts buys these bonds, it's as if they are buying their own states tax-exempt paper.
And when I use the word investor, this includes individuals, hedge funds as well as widely held tax-exempt mutual funds.
Another reason for the popularity of Puerto Rico bonds is when a state does not have a deep supply of municipal bonds issued within its own borders. Investors there can look to Puerto Rico as well.
But truth-be-told, particularly in the new normal of ZIRP (the Fed's zero interest rate policy), additional investors that don't fit into the two categories mentioned above are also buyers of Puerto Rico paper for another historically atypical reason.
Bonds issued by Puerto Rico entities have tended to have juicy (higher) yields relative to similarly rated bonds found elsewhere around the country.
Why, you may be asking yourself, do these bonds need to offer higher yields in order to entice buyers to buy them?
If we go back to Investing 101 the answer is basic: Higher Risk = Higher Reward!
Is Puerto Rico America's Greece?
So how did Puerto Rico get to a point where it became so heavily debt-laden that it went into a state of crisis culminating in yesterday's default? Here is a description (Source):
Changing the numbers and replacing Puerto Rico with Greece, the stories, and the problems that are facing these two debt-issuing entities, sound very similar.
Real Solutions Will Be Hard To Produce, PARTICULARLY In An Election Year!
What all of this means is that any 'solution' will likely entail more kicking of the can down the road by Congress, with debate surrounding it that will undoubtedly be laced with ideological vitriol intended to pander for votes for the upcoming presidential and ancillary elections!
Here's a small taste of the rhetoric to come as a potential solution for a bad situation is explored... (Source):
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