Government Default – It’s Going Around

At the end of June 2015, Puerto Rico’s governor announced the Commonwealth was unable to repay the $72 billion in bonds and obligations it has amassed.  The debt load owed by the 3.6 million Puerto Ricans is $20,000 per capita.  In comparison, the current debt crisis in Greece is more severe at $28,475 in per capita debt owed mostly to other governments.

US consumers are watching slow-motion financial wrecks in Greece and Puerto Rico.  Both show what happens when a government allows expenditures exceeding revenues to become the chronic state of affairs.  For a long time, Greece was able to borrow other people’s money to fund a comfortable life with early retirement and good pensions.

Lately, the European Union realized Greece will not live within its means unless its adherence to austerity is closely monitored.  At the end of June 2015, Greece is conducting a referendum on whether to submit to protracted austerity in return for restructured debt or to default on its debt and probably leave the Eurozone.

Greece misbehaved for so long that many US banks have ceased holding its bonds, however, the International Monetary Fund and European Central Bank have continued offering Greece credit and they are likely to feel the impact of a Greek default.  US consumers should feel little impact from whatever Greece decides to do.  But, the US consumer might feel volatility from several large coincident factors; a correction in Chinese stock markets, Puerto Rican debt, and the specter of rising interest rates through Federal Reserve action as early as September.

Puerto Rican government and utility debt have been popular with US pension and mutual funds because they offer relatively high yields and their dividends are exempt from federal, state, and municipal tax.  Any restructuring that Puerto Rico negotiates with creditors will have an impact on the savings of some US consumers, albeit diluted if their savings are held by a well-diversified lender.

Puerto Rico’s triple tax exemption made bond buyers eager to purchase its bonds, even though the money was used to plug government budget gaps and refinance bonds coming due for redemption.  That led to excessive reliance on Puerto Rican bond issuance during the ongoing 9-year recession coupled with high unemployment.  Some Puerto Rican money troubles mirror Greece’s problems, including inadequate collections of taxes, excessive retirement entitlements and labor laws that make it difficult to remove a non-performing employee.

On a per capita basis, Puerto Rico’s debt is less severe than Detroit’s ($26,655 per capita), but more severe than Illinois ($12,691 per capita). Of course, Illinois has not yet declared bankruptcy. When Stockton California declared bankruptcy, it had debts and obligations of $2,315 per capita. When Jefferson County, Alabama declared bankruptcy it had a per capita debt of $6,356.

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