Puerto Rico – an objective view.

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Today Puerto Rico defaults on their first sizable bond payment (approximately $400m). As I write this, I sit in the heart of Old San Juan and if I had a strong enough arm, I could hit the Governor’s mansion with a baseball. I was working yesterday (Sunday) at the office as the protesters took to the streets – rallying against the Fiscal Control Board. I expect more protesting today. I have been here, on and off, for several months and becoming acutely aware of the economic landscape and government situation from ground zero.


Puerto Rico


courtesy of wikipedia

I would like to think I am an objective observer. I am not a member of any Puerto Rico political party, nor am I a member of any US political party. I am not a journalist and at best an autodidact economist. As I have been spending time here – I have been making my own observations. I hope this serves as a basic primer (from an objective gringo) for those interested. I also share some of my thoughts and conclusions on what’s next. I try to write without any political bias and reflect the position of both parties fairly.

What is actually happening in Puerto Rico, both on the ground and economically speaking is far different than what the media in the US has been reporting. In many ways Puerto Rico is foreign to what most of us in the US are accustom to. I am not just talking about the culture, language, food, or even Salsa. I am speaking exclusively about politics, ideology, and economics.


Private vs. Public

Tale of two cities. There are two private sectors in Puerto Rico. One is a vibrant private sector. Several areas in San Juan are booming – new restaurants, new building, and gentrification. The massive mall, Plaza Las Americas, is bustling. The Cheesecake factory is full and people are shopping. There are excellent restaurants, which are full of patrons. Buildings that I have visited are loaded with new Act 20 businesses. Several have no room, as they are full with these new businesses and some even have waiting lists. I have run into several computer software companies, bio-tech, medical device, and investment firms. My only criticism of Act 20/22 is that it is not marketed well in the US. It doesn’t help that the current political fiscal crisis is a huge cloud creating trepidation for new investments and companies coming here. It is just not growing fast enough to help off-set the many leaving the island. Yet it is bringing money and jobs to the island.

There is another private sector, which I have also seen, and this consists of a large pool of unskilled labor and is the low income sector. Unfortunately this is the largest part of the population. Social welfare per capita is larger than any state in the US. Many have so many social services they rely on, that getting a job becomes a determent. It becomes a determent, in that they could lose some of those services, which they rely on, by merely getting a job. Even paying above minimum wage would not help many, because the cost of housing, food (mostly imported – see Jones Act), and energy prices are insurmountable. Generations have become dependent on government social programs and the costs (inflation) keeps rising. I don’t pretend to know the answer – but this is a serious problem that needs to be solved. It will not be easy and it will take efforts and sacrifices by all to solve this problem. It is this part of the population that is tethered to the government, also the biggest voting block and the bulk of the protesters against the fiscal control board or anything that may mean cutting entitlement, social, and welfare programs.

Public sector – the government is deeply enrooted in almost all services from energy to banking. Over 50 government run companies and 100s of thousands of government employees. Approximately 30% of the work force, work for the government or affiliated agency. It is about 8% of the population, over 250,000 government workers. Government payroll is about 18% of the annual budget. For comparison, California’s state government is only about .6% of the state’s population and payroll accounts for about 4% of the annual budget. By any standard, the Puerto Rico government runs very heavy when compared to the US Federal or US state percentage of employees and budgets. There are several answers to solve this, one that may have traction in both parties is to move many agencies into a Government Sponsored Entities (GSE). That means it is not totally privatized, but perhaps hiring private management companies to run these entities can take on the liabilities (note – they could just hire the people that already work there). Additionally, the government could set it up to receive a percentage of top-line revenue, without the liabilities and that could be a huge stream of revenue while also cutting the deficit spending. Of course I just simplified a rather complex idea, but in general it is something to be considered. Sure, many may say just privatize – but that is a very hard pill to swallow for many. A compromise is an easier solution in the short-term and cuts deficits and could generate income, while keeping jobs. Win-win-win.


Political Parties

The political parties in Puerto Rico, for those in the U.S., is kind of hard to understand. It is not equally divided between the Republican and Democrat parties we are so familiar with. The two primary parties are:


courtesy of wikipedia

Partido Popular Democratico (PPD) or Popular Democratic Party. They are Pro-commonwealth. The governor, Alejandro Padilla, is a member of this party. This party is against the Fiscal Control Board and has pushed for Super Chapter 9 Bankruptcy. Now let me make this clear, not all members of this party support Bankruptcy and not all are against the Fiscal Control Board. This only adds to the complexity of the situation in the party. The Governor is also not running for re-election. This party also controls both the Congress and Senate in Puerto Rico


courtesy of wikipedia

Partido Nuevo Progresista (PNP) or New Progressive Party. They are Pro-statehood. They have, in general, supported the Fiscal Control Board and do not want to file for bankruptcy. They are the minority in both houses.

For very simple dividing lines, the PPD party leans more towards the US Democrat Party, while the PNP party leans more towards the US Republican Party. However, that is not totally true on many issues. On many social issues, Puerto Rico is a strong Catholic and conservative place and you find a conservative vein on these issues in both parties. On social welfare and corporate welfare issues, the lines are also blurry. If you are a Democrat or Republican in the US it would be rather hard to figure out which party best represents your values. I do find it interesting that both parties are similar in many respects, want many of the same things, and the real dividing line is how they affiliate themselves with the U.S. Federal Government. Of course, like with all politics, they don’t seem to think they are a like at all.

There is also another party, rather small compared to the two major parties, called the Puerto Rico Independence Party (PIP) – which would rather just cut the ties with the US all together and become an independent nation. I would think that it would be a more popular party with all the volatility Puerto Rico has with the US, but Puerto Rico’s co-dependent relationship with the US makes it hard for cutting off the relationship all together. There are also a few other parties like the Working People’s Party (PPT) and Puerto Rico for Puerto Rico party (PPR), which are more ideological in nature, but they too are small in relation to the two major parties.

I have been told that politics is the national sport in Puerto Rico. I have made many friends in both parties, I understand and see their respective points of view. However, as I am not a member of the US Democrat or Republican Party, I think it best that I continue to remain independent. My focus is simply economics, devoid of party politics. I tend to vote for the best economic idea and the best person/people to execute that plan – based on my opinion, of course.


Fiscal Control Board

The idea of the Fiscal Control Board is to have a group of objective individuals (not Puerto Rico government of any party), to come in and manage the budget, bills, taxes, bond payments, etc. The idea of the Fiscal Control Board to many in Puerto Rico (especially the current party in power – PPD) is hard to fathom. The primary issue is that any Fiscal Control Board castrates the power of the local government and moves it to Washington DC. In effect the US becomes the actual government and power behind Puerto Rico. Those that control the purse strings are the ones that have the real power. Any Fiscal Control Board is going to enact austerity measures. However, there are many here that support the Fiscal Control Board, including many in the opposing party, PNP. These people have lost trust in the Puerto Rico government and their ability to manage the budget.

Bond holders are in general supportive of the Fiscal Control Board, but only if it contains very pointed and direct litigation language. Ultimately, bond holders want to – of course – make sure they get their 100 cents on the dollar. If the Fiscal Control Board can’t solve the problem, they want to have the back-up ability of full litigation – as they also don’t fully know or trust if/how the Fiscal Control Board would work.

I personally am uncertain as whether it is a good idea or not, mostly because I am not sure how it would be implemented. I have heard compelling reasons why they should and should not have one. Ideally, I would be against it, as I think everyone would – if the local government could solve the fiscal problems. They certainly can solve the problem, if they are willing to and the only reason that a Fiscal Control Board is even suggested is that many feel the government will not take the necessary actions to solve the problems. I fully appreciate and understand the party politics, much like in the U.S. – the party in office is blamed (PPD) and the other party must support positions that appear to cripple the other party. However, I wonder if the other party, PNP, that supports the Fiscal Control Board realizes it will not just eviscerate the PPD party, but if the PNP takes power after the election – it will equally affect them in governing. Whether I support the idea or not – I am not sure at this point – I think it is important to understand this will impact ALL of Puerto Rico – regardless of party. If no one can or will solve the problem, perhaps the Fiscal Control Board is the option.

I Cannot imagine a State giving up State’s rights and fiscal control to the Federal Government. I think all the other 49 states would go nuts and rebel against the Federal Government in an apparent attempt to take over State control. Talk about a catalyst for a revolution. Yet this is Puerto Rico, not a State or a Municipality. Many American’s don’t even know it is part of the U.S.


Super Chapter 9

States in the US cannot file for bankruptcy, under Federal Law. Only municipalities can file for bankruptcy, like Detroit. Puerto Rico is neither a State nor municipality. I am not sure why in 1984 that bankruptcy was removed from Puerto Rico. Perhaps it was thought that Puerto Rico should not be given the same advantages as municipality. I wonder if perhaps the decision to remove this option came along with the thoughts of Puerto Rico issuing debt. Regardless, it does not seem like this is even an option at this point. There is far too much money at risk and lobbying to protect bond holders. There are legitimate concerns that if Puerto Rico could declare bankruptcy other states would try to follow suite, like Illinois.


Bond Holders

There has been lots of misrepresentation in who are the bond holders. One only has to use logic and reason as to who were the initial bond holders, as it was the same investors who buy muni-bonds. They were those seeking principal security and income. They were rated like many other muni-bonds, but they also afforded some additional tax advantages (triple tax exempt).

When the bonds were issued it was not hedge funds or even vulture funds swooping in to buy them, rather it was pension funds, retirees, conservative investors and other typical muni-bond buyers. Muni-bond funds were even created that held PR bonds.

It was after the problems began to happen, yields rise and bonds fell, that hedge funds and then vulture funds started flocking onto the scene. Even today, only about 30% of the outstanding bond holders are classified in the hedge fund space, the vast majority remains in investment funds that regular people – not in the financial industry – own. Teachers, retirees, engineers, pensioners, managers, also own these bonds – directly or indirectly in a bond fund, pension fund, or investment fund. I haven’t even mentioned the 1,000s of Puerto Ricans that own these bonds, investing in their own nation.

I understand that thought process – my Grandmother (100 years old), bought and owned GM bonds, as my Grandfather was an engineer for GM and thought buying GM bonds was safer and better than buying GM stock (like many conservative investors). I was sadden and even mad when the media said it was hedge funds that owned GM bonds and didn’t want GM to default on them. Sure they owned some, but my Grandmother also had the majority of her life savings in them (for better or worse). She received 30 cents on the dollar (between stock/warrants) and it wiped out the majority her savings. My issue is the miss characterization by the media.


courtesy of wikipedia

Just like real vultures, there is a need for vulture funds. They only swoop in when liquidity dries up. Imagine you are a Puerto Rico bond holder and no one wants to buy your Puerto Rico bonds. If a vulture shows up and says – “Hey, your bonds might be worthless or they could be worth something – you don’t know, but I will buy them for 50 cents on the dollar today and take that risk off your shoulders!”. Now it is not like the vulture fund stole these, they are creating liquidity in an illiquid market. As a bond holder, it is a legitimate offer and you can either take the risk and hold them or sell them for a lost and get something, rather than potentially losing everything. Ironically, I wish my Grandmother had a Vulture offer her 50 cents on the dollar for her GM bonds. She would have made 40% more than what she settled for. So while they get a bad name in the press and they seem nasty and ugly, they do – just like on the plains of Africa – serve a purpose.


US Congress

I believe that Puerto Rico is putting too much faith and hope in the US government. The Puerto Rico government – to a certain extent – is living in their own bubble. They think the only issue on the US government’s plate is what is going on in Puerto Rico. The US Congress has lots of other problems and Puerto Rico is just one of many. Additionally, US is going through its own elections and not just for President. Many Congressional seats are up for election and depending on their constituency will either be for or against any type of Puerto Rico solution. There are Republicans running in Florida Congressional districts with a high number of Puerto Rico and Latino voters, who are aligning with solutions that they may not normally support – working across party lines. Additionally, there are Democrats in non-Latino communities that are getting push back and will ironically support a more Republican approach.


courtesy of wikipedia

Regardless of which side the Congress member supports (Chapter 9, Fiscal Control Board, or something else) – you can be sure they will become a poster child in attack ads from the opposition. Current attack ads on TV have both Paul Ryan (R) and President Obama in it – aiming squarely at both US parties at the same time. Perhaps it is not worth the risk, as a Congressman, to take any action at this time – as they run for office.

Even if Congress pass legislation, it is only the first of three steps. It has to go to the Senate and then to the President to be signed. We know how well Congress, Senate, and President have worked together. Both parties can’t even solve their own primary voting issues, let alone appoint a judge, or pass their own budget. So solving Puerto Rico’s problems is not only low on their agenda, but a political hot potato in an election year.

And now the current Fiscal Control Board legislation is getting changed again, as Union representatives met with Democrats (Pelosi) and pretty much threaten to drop support for the Democrats who are up for Congressional elections if they do NOT remove the bond litigation language in the current Fiscal Control Board bill. That will certainly not fly, because bond-holders (of all stripes) will lobby to keep it in and threaten Congressional members who take it out by with-holding support in the election. Talk about a Kobayashi Maru scenario (no win)!

I doubt any real solution will be resolved by US Congress anytime soon and the best they could hope for is a Band-Aid (can-kick) in July (big bond payment) and nothing really until after the election. And after the election you have the risk of who controls Congress and who is the next President.


Conclusion

Personally, I think Puerto Rico could solve a good chunk of their problems (both short-term and long-term) on their own. They don’t need to completely default and also don’t need a Fiscal Control Board. However, that requires some objective leadership and one that is not steeped in political party ideology. The choices will not be popular – but they would solve the problem and help Puerto Rico move forward.

There are legitimate complaints that Puerto Rico has with the US government; everything from certain programs that are underfunded, Jones Act, and a host of issues. Puerto Rico should head to Washington and fight for these issues, but it will take time and they may not get exactly what they want. Members of both Parties are taking this approach with the current fiscal crisis and unfortunately putting all their eggs into this basket, betting on Congress doing the right thing and quickly. The problem is the “right thing” depends on who you ask, and quickly in government is measured in months (perhaps years).

Fight the fight in Washington, but also – more importantly – take responsibility and accountability for the current state of affairs and look to solve as much as you can from within, on your own, and from those willing to offer help.

By helping yourself and looking for solutions, you encourage both Congress and bond holders that Puerto Rico is trying to solve the problem themselves as best they can. People want to help those that help themselves. Puerto Rico will certainly need Congressional help and also work with Bond holders, but doing what you can to help solve it on your own – today – is the most important first step.

The clock is ticking, July 2016 is the whopper bond payment of $1.9 billion. Can Puerto Rico afford to bet on Congress to pass legislation in both Houses, which the President will sign – that will meet the needs of Puerto Rico and bondholders? I don’t think so, Congress has been fumbling this ball for months. Today Puerto Rico defaulted on $400m and Congress did what exactly? Nothing, they didn’t even hold a press conference, hearing, or emergency meeting. In fact US Congress this week is out on Vacation! Seriously, Puerto Rico needs to start – today – trying to solve some of these problems on their own.

It will get worse – before it gets better, but it WILL get better.


Note:
Why am I here? Well it is a lovely island, I love the people, culture, food, music, and certainly Salsa (note: I have taken lessons). We initially came here to meet with a couple of businesses/investors, as local banks and investments dried up as the fiscal crisis grew. That initial meeting spawned several more meetings, to a level that we have now become active in Puerto Rico. I have been spending lots of time here, flying back and forth to Florida is not too hard.

I have been to most of the islands in the Caribbean, including Cuba. While they are all lovely and great vacation destinations, few offer the infrastructure to be an economic force beyond tourism. Puerto Rico, in my opinion, is the jewel of the Caribbean. It has several huge deep-water seaports, free-way systems, manufacturing, water/electrical grids, storage facilities, potentially massive agriculture, universities, shopping centers, and a multitude of cities. There are Best Buy and big-box stores, movie theaters, Cheesecake factories, and pretty much everything you would find state side. It is also a US territory, you don’t have to give up your citizenship to live here.

Puerto Rico, as this crisis resolves, could very well be a super growth center. I see the opportunities in Puerto Rico’s future for both jobs, businesses, and investments. But for right now, we must move through these difficult times.

We can hope cooler heads will prevail.

By the way, Mr. Governor – if you need help, advice, or anything – I am just a baseball throw away at Plaza de Armas.

4 Responses to “Puerto Rico – an objective view.”

  1. Bob Lucas says:

    Great write up Michael…Thanks!

  2. Kelly Maher says:

    Thank you for writing such a comprehensive analysis of Puerto Rico’s dilemma. I have noticed the Super 9 Chapter Bankruptcy TV ads. Now I have a better understanding of their situation.

  3. Ann Kolesar says:

    Very informative! I appreciate your thoughts, and I hope that this will be a catalyst for some change and reform.

  4. Phil Handin says:

    Well-written, thorough analysis, Michael.