Puerto Ricans fleeing debt battle by Michael A Fletcher
Tax increases, pension cuts and a fall in jobs are part of the strategy to save Puerto Rico from another rating downgrade
Boxes and wooden crates filled with household items bound for the US mainland are stacked high in the Rosa del Monte moving company's cavernous warehouse, evidence of the historic rush of people abandoning Puerto Rico.
The economy has been in recession for nearly eight years, crimping tax revenue and pushing the jobless rate to nearly 15%. Meanwhile, the government is burdened by staggering debt, spawning comparisons to bankrupt Detroit and forcing lawmakers to severely slash pensions, cut government jobs and raise taxes in a furious effort to avert default.
The implications are serious for Americans outside Puerto Rico both because a taxpayer bailout would be expensive and a default would be far more disruptive than Detroit's record bankruptcy filing. A federal bailout is not on the table, but the situation is being monitored by the White House, which recently named an advisory team to help Puerto Rican officials navigate the crisis.
The island's problems have ignited an exodus not seen there since the 1950s, when 500,000 people left for jobs on the mainland. Now Puerto Ricans, who as citizens are free to move and work anywhere in the US without passports or green cards, are again leaving in droves. They are choosing the uncertainty of the job market in Orlando or New York City or Philadelphia over what they view as the certainty that their dreams would be crushed by the island's grinding economic problems.
"We used to move a lot of machinery into Puerto Rico, and executives who worked in the pharmaceutical industry here," said Neftaly Rodriguez, whose father founded Rosa del Monte. "Now we are packing people up to go out. Everybody is looking for a better opportunity."
Puerto Rico lost 54,000 residents – 1.5% of its population – between 2010 and 2012 alone. Since recession struck in 2006, the population has shrunk by more than 138,000 to 3.7 million, with the vast majority of the outflow headed to the mainland.
The brutal combination of a long recession, a shrinking population and overwhelming debt has left Puerto Rico's political leaders struggling to manage a conundrum: how do they tame at least $70bn in debt while marshalling the resources to grow a shrinking economy and battlecorrosive social problems, including a murder rate nearly six times the US average?
The crisis has left Puerto Rican governor Alejandro García Padilla juggling competing demands for budget cuts and other types of austerity demanded by Wall Street rating agencies, and the incentives and other spending needed to ignite growth.
"Sometimes you are between the wall and sword," Padilla said in an interview.
Not long after Padilla took office in January, Wall Street debt rating agencies downgraded the island's bonds to just one rung above junk status. Like states, the commonwealth of Puerto Rico cannot file for bankruptcy. Also, its constitution offers bondholdersstrong guarantees that they would be paid before pensioners and public workers if the government went broke. "I can assure you that Puerto Rico will not default," Padilla said. "Puerto Rico will pay our debts. It is a constitutional obligation. But for me it is also a moral obligation."
Still, with Detroit's bankruptcy filing fresh in the minds of investors, the downgrade ignited widespread concern that the island was sliding toward default, which would hurt many investors across the US. Because of their high yields and exemption from federal, state and local taxes, Puerto Rican bonds are held by three out of four municipal bond mutual funds, according to Morningstar, a market research firm.
"Some people might say, 'This is their problem.' But Puerto Rico is part of the United States, you own this problem," said Pedro Pierluisi, a Democrat who is Puerto Rico's non-voting representative to Congress. "It is not like you can ignore it."
For now, the debt problems have done damage mainly in Puerto Rico, where it substantially raised loan costs for a government that has come to rely heavily on borrowing to fund its daily operations.
"You cannot pay daily expenses with your credit card, and that's what Puerto Rico has been doing for years," said Deepak Lamba-Nieves, research director of the Centre for a New Economy, a San Juan thinktank. "We borrowed just to keep the lights on."
Puerto Rico's expansive web of debt includes standard government bonds as well as those floated by public corporations, including authorities for water and sewer, highways and electric power. Together those bills have nearly tripled since 2000, as successive administrations turned to the bond market to plug gaping budget deficits. In addition to the $70bn in government debt, the government also faces $37bn in unfunded pension obligations, according to Morningstar.
First, shoe factories and textile mills dominated the economic landscape. Later, pharmaceutical firms turned the island into a hub of drug manufacturing. According to one investor research report, 16 of the 20 top-selling drugs in the US are made on the island. But eventually many of the clothing plants moved to more promising ports. Then a series of key drug patents expired, contributing to a sharp decline in manufacturing. Since 1996, the number of factory jobs in Puerto Rico has plummeted from 160,000 to 75,000.
And while government workers make up about a quarter of the commonwealth's workforce – much higher than the US average of 16% – their ranks are shrinking as the pervasive debt and economic problems careen toward a reckoning. Now, just over 41% of working-age Puerto Ricans are in a job or looking for one. Miguel Rodriguez, 50, who was working on his résumé at a government employment office in San Juan, said he has been out of work for four years, making it difficult to support himself or pay child support. He noted that his plight is not unusual. "Here, it is very hard to find a job," he said.
As work has disappeared, more Puerto Ricans have relied on the government to survive: about a third of the population relies on food stamps All of those problems were compounded by a housing bust that took down three of the island's banks, while leaving many Puerto Ricans as deeply in debt as their government.
Now pawnshops and title loan operations, which give loans to people who put up their car titles as collateral, are a growing presence on the island.
At a Borinquen Title Loans office located in a former bank branch outside San Juan, an employee inspected a potential customer's car in the small parking lot, while inside, employees were busy on computers.
"We see all kinds of people here," from former professionals to out-of-work labourers, said area manager Rosemarie Velazquez. "Business has been good."
Restoring economic growth is a top priority for Padilla, whose signature campaign promise was to create 50,000 jobs. That would normally call for spending, tax cuts and investments. But his other top priority, bringing the debt under control, calls for the government cutbacks and tax increases.
Since taking office, he has tried to do both.
Under pressure from the rating agencies, Padilla has enacted $1.3bn in taxes, including increased corporate taxes, a broadened sales tax and a new gross receipts levy. The percentage increase in taxes is far larger than what the federal government has ever imposed, according to Richard Larkin, senior vice president of H J Sims, an investment firm.
"To say that Puerto Rico's tax increase for 2014 was monumental is an understatement," Larkin wrote.
He has also continued government job cutsbegun by his predecessor. Together the two leaders have cut about one in 10 jobs from the public payroll. The changes have put the government on course to shrink the current year's budget deficit from an estimated $2.2bn to about $870m. The aim is to eliminate it by 2016.
To bolster the underfunded government pension plans, Padilla shifted many workers from traditional pensions to employer-sponsored retirement plans, while raising retirement ages and increasing employee contributions to the plans. He also promised a series of increases in the government's pension contributions to fortify the severely underfunded plans.
Economic development officials are stepping up efforts to generate growth on the island. The government has enacted tax incentives and offered electricity credits to entice firms that might be discouraged by Puerto Rico's electricity costs, which are double the average on the mainland.
Officials are searching for an operator for a $300m port project that can handle the mega-ships that will soon traverse an expanded Panama canal, and they are working to bolster the tourism trade, which accounts for a paltry 6% of the tropical island's economic activity.
They say they already are seeing success, including new air routes to the island and commitments to build hundreds of new hotel rooms.
"[Previously,] we were lazy and complacent," said Alberto Baco, Puerto Rico's secretary of economic development and commerce. "Now we have to act fast."
But it remains to be seen whether the government's actions will be enough to stave off the crisis.Last month the rating agency Fitch warned that Puerto Rico's general obligation bonds could be downgraded to junk status next summer because of concerns that the commonwealth would be unable to return to the market any time soon to borrow more at a reasonable cost.
Another downgrade would be a severe blow for Puerto Rico, effectively cutting it off from the market and paralysing its efforts to dig out from under its mountain of debt. If that happens, Lamba-Nieves, said, the federal government could feel pressure to step in with a bailout.
"Puerto Rico might be a little too big to fail," he said.
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