Generational Dynamics

John J. Xenakis

Puerto Rico bankruptcy may be imminent, potentially a 'seminal event'

Marilyn Cohen, the CEO of Envision Capital Management, appeared on Bloomberg TV on Friday to analyze the debt situation in Puerto Rico. According to Cohen, a $70 billion bankruptcy in Puerto Rico is a virtual certainty, as early as July.Many people have invested in Puerto Rico bonds because they pay 10% interest (yields) and because under federal law they're "triple-tax free," meaning that you can earn 10% interest every year and not have to pay federal, state or municipal tax on the interest you collect. It's a sweet deal, provided that Puerto Rico doesn't go bankrupt, because if it does, then you lose most or all of your initial investment. 

According to Cohen, the unemployment rate is 13.7%. Only 700,000 of the 3.5 million people, or 20%, work in the private sector. The other 80% either are on welfare, or they receive unemployment or other aid, or they work for the government. Year after year, Puerto Rico sells more and more bonds, and investors eat them up because of the high tax-free yields. But now their string has run out. 

According to Cohen, the bankruptcy will hurt a lot of people. She compares it to the Detroit bankruptcy, which didn't really hurt too many people -- the bankrupt debt was $18 billion, but few ordinary people owned Detroit bonds, as most investors were institutions that hedged their purchases with credit default swaps. 

But Puerto Rico's debt totals $70 billion, and she says that huge numbers of ordinary investors are going to be hurt. Even if they don't individually own PR bonds, they own them through their 401k's or other investment funds, which have been boosting returns by purchasing the PR bonds. These funds will all lose significant principal in a PR bankruptcy. According to Cohen, this bankruptcy will be a "seminal event." 

After Detroit and Puerto Rico, Cohen says that the most likely next municipal bankruptcy will be Chicago, whose finances are "a mess."

DYI