S&P Downgrades Puerto Rican Debt to Junk Status

By:  Bob Adelmann
S&P Downgrades Puerto Rican Debt to Junk Status

Now that credit rating agency Standard & Poor’s has ended the suspense by announcing that it is cutting Puerto Rico’s $70 billion worth of general obligation bonds to junk status, questions about the island’s economic future abound.

Will Fitch and Moody’s follow suit as they warned they probably would back in December? If the country can’t arrange other financing to cover its budget shortfalls as it has been doing since 2000, what will happen? With 70 percent of triple-tax-exempt bond funds in the United States holding some Puerto Rican debt, how much money will their investors lose? What will happen when investment managers who can no longer legally hold junk bond debt in their portfolios try to sell what they already have? To whom? For how much?

What about the hapless 3.6 million taxpayers on that balmy tropical isle? Will they be required to suffer further mulcting? What about the American taxpayers? Will the Obama administration bail it out with their taxes?

The Puerto Rican government has managed to sell $70 billion worth of its paper to investors, taking advantage of the subsidy already provided by the federal government in the form of allowing interest payments to be free from taxes at the federal, state, and local level. Since Puerto Rico is a territory under the Constitution (see Article IV, Section 3), it is subject to congressional mandates in nearly every area, including citizenship, its currency (the dollar), the U.S. Postal Service, foreign affairs, military defense, communications, labor relations, the environment (yes, even the EPA), commerce, finance, and health and welfare (i.e., Social Security).

The downgrade from Standard & Poor’s came much more rapidly than even Michelle Kaske expected. On January 29 she suggested in Bloomberg that Puerto Rico was in danger of losing its investment-grade rating, noting that it would raise the cost of servicing the country’s existing debt by a billion dollars a year.

The very next day Kaske quoted analysts at UBS Wealth Management who expected at least one of the credit rating agencies to cut Puerto Rican debt to junk within the next 30 days. That same day, Standard & Poor’s pulled Puerto Rican bonds from its tax-free municipal bond index, explaining that they “no longer meet the objective established by this investable investment-grade index.” Four days later S&P made its announcement, with widely held speculation that Moody’s and Fitch aren't far behind.

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