May 5, 2017

Puerto Rico Bankruptcy a Flashing Warning Sign for the US

Peter Schiff

Puerto Rico officially plunged into bankruptcy this week. Years of accumulating debt and misguided government policies finally reached their inevitable end.

The bankruptcy means more pain for the people of Puerto Rico, as well as bondholders who have virtually no hope of ever getting their money back. But beyond that, it serves as a giant, flashing warning sign, because the truth is, the financial condition of the the US isn’t fundamentally different than that of her island territory.

Puerto Rico has racked up some $123 billion in debt, including about $74 billion in bond debt and $49 billion in unfunded pension obligations. According to the court filing, the US territory is “unable to provide its citizens effective services.”

Puerto Rico has been creeping toward this climax for nearly a year. Last summer, Congress sent a bill to President Obamaís desk crafted to help the commonwealth work its way out of its debt crisis. The bill didn’t allocate any federal funds to bail out Puerto Rico, but it did set the stage to allow the islandís government to pay back debtors at less than 100%. For all practical purposes, it created a bankruptcy process for Puerto Rico, even though the word “bankruptcy” wasn’t in the billís language.

And here we are.

So, how did Puerto Rico get into this mess in the first place? A USA Today report actually did a pretty good job of summing it up – heavy debt, government bureaucracy, and high taxes.

Basically, the Puerto Rican government just did what governments do. It promised people the moon, and then borrowed money and ran the economy into the ground trying keep those promises. And it got some help from Uncle Sam along the way. Congress, imposed the US minimum wage on the territory and tied a giant millstone around its economyís neck. On top of that, federal law encouraged and facilitated a Puerto Rican government spending spree. Vox summed up the root of the crisis nicely.

“If youíre just tuning in, for years a quirk of US law created a tax subsidy for Puerto Rican debt that encouraged middle-class Americans to binge on loaning money to Puerto Rico without really realizing thatís what they were doing. The Puerto Rican government took advantage of this situation by borrowing a lot of money, but didnít use the money to accomplish much that was useful in the long term.”

Then government came in and tried to fix the problems government caused in the first place. Reaching this point was really inevitable.

And that brings us to the flashing warning signs. There is very little difference between the financial situation in Puerto Rico and the financial situation on US the mainland. Puerto Rico is just a little further down the road. Even the New York Times sounded the warning in a recent report about the bankruptcy.

“While many of Puerto Ricoís circumstances are unique, its case is also a warning sign for many American states and municipalities ó such as Illinois and Philadelphia ó that are facing some of the same strains, including rising pension costs, crumbling infrastructure, departing taxpayers and credit downgrades that make it more expensive to raise money. Historically, Puerto Rico was barred from declaring bankruptcy. In the end, however, financial reality trumped the statutes, and Congress enacted a law last year allowing bankruptcy-like proceedings.”

In the end – financial realities always trump laws, policies and government actions.

The New York Times focused on the crisis looming over some American cities and states, but what about the US federal government? It’s piled up some $21 trillion in debt with no end in sight. It continues to ratchet up spending. It promises more and more “services” to its citizens, including funding their retirements and paying for their healthcare. The CBO says if something doesn’t change, the US is on a fiscal road to hell.

When you step back and look at it, the only difference between the US and Puerto Rico is that the US can print more money and keep ratcheting up the debt ceiling. But all that really means is the US government can build a bigger house of cards.

At its fiscal core, the US is just Puerto Rico, and the house of cards will collapse.

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