Exiting the Puerto Rico Debt Crisis

In a thought provoking piece from the Bloomberg View, the editors are recommending that Puerto Rico be allowed to slip into bankruptcy.  A bold suggestion, that I’m sure will ruffle some feathers, but it is not without merit.

As some of you know, I’m a serial entrepreneur with a long string of failed businesses.  In some circles this would grant me a badge of honor, for me, it’s just another badge I’ve accumulated in a long career.  When building a startup, it’s critical to know your exit plans; do you intend on taking the company public, do you hope to sell it, or will this become a life-style business?  So for purposes of a thought experiment, let’s apply the same analysis to the Puerto Rico debt crisis.

You can file this under more assumption analysis of our debt problem, but let’s say that we have a magic wand, and the VAT(IVA) works perfectly. Then what?  We see right away, that we just can’t get away from revisiting our assumptions:

• $79 Million in outstanding bonds.
• Interest payments of these bonds are 13% of our annual budget.
• S&P and Moodys determine the grade of our bonds, their grade determines the amount of interest our government must pay on both outstanding bonds and new ones as well.

To solve our debt problem, the VAT(IVA) must produce a budget surplus, or at the very least, balance the budget so we don’t need to issue any more bonds.  Additionally, the VAT (IVA) should prevent any further degradation of outstanding bonds.  Further degradation means that the VAT(IVA) would have to overcome the additional interest due.

Here’s what the Bloomberg View editors have to say about that:

“Shrinking Puerto Rico’s debt will require running a budget surplus for years and an economy that grows at a nominal rate consistently higher than the interest rate on Puerto Rico’s debt. Neither is likely.”  

Let’s be clear, the goal is not to eliminate all bonds, but to bring them under control and eliminate the burden of massive interest payments we currently have.

It is a simple truism that you can not solve a problem quickly that took decades to create.  The VAT(IVA) is not a silver bullet solution.  Even with perfect execution, one that generates a budget surplus, we would still need to keep that surplus until the public debt is under control.

Troubling Unknowns

• How will an aging tax-base impact collections? 
• What if more citizens take their chances in the United States and move away?
• What if citizens find a way to avoid paying the VAT?  A common solution to not paying tax on a purchase is to find an alternative source, can you say Amazon? What about Ebay.  While we try to tax Internet purchases? Hmm, good luck with that one.
• With Radio Shack and Doral Bank ready to disappear, how will additional business closings affect the problem?  
• What if the federal government raises the minimum wage?

I used a dominoes analogy of our debt crisis early, but chess will do just fine.  If our debt crisis is like a game of chess, then we are only just a few moves away from checkmate.  With each move we take, we move one step closer to checkmate, so now the question becomes, "What happens when Puerto Rico defaults on our bond payments?"  Let's explore that scenario, but be prepared for one thing, much wailing and gnashing of teeth.