Puerto Rico is in complete financial meltdown.
The basic premise of the saga makes sense.
A big, semi-sovereign government has indebted itself as much as the state of New York, it missed an interest payment on its debt, it’s in default and there’s no easy way out.
But at this point we have to wonder is the fear of Puerto Rico’s problems spreading throughout the rest of the markets really justified?
The mainstream financial media sure would like us to think so.
Marketwatch warns us, “Puerto Rico poses bigger threat to U.S. investors than Greece.”
Luckily for us, this isn’t Puerto Rico’s first debt-crisis rodeo.
So a quick review of history and a look some failsafe market indicators (as opposed to media hyperbole) will give us a much better idea of how big a problem this is all going to be.
Will Puerto Rico Send Stocks Plummeting?
There are three major points very few are talking about the Puerto Rico situation right now.
Altogether they give us a very good idea of how big an impact Puerto Rico will have on the world financial markets.
The first major point is history.
Puerto Rico already had it’s big run when it’s a “new era” and “this time it’s different” when a crisis is unexpected.
It was back in 2005 and 2006 when the rest of the world was, comparatively, doing quite fine.
Do you remember it? Did you even hear about it? Were you in any way affected by it?
It’s Puerto Rico. It has a GDP about 0.6% the size of the size of the U.S. GDP. And its only 50% bigger than Cuba which has been in a depression since 1959.
However, for Puerto Rico, the 2005/2006 crisis was a big one.
A real estate bubble collapsed, banks collapsed, the government ran out of money, and government workers went unpaid.
It’s chosen solution was higher taxes and more borrowing which isn’t really a solution at all.
So even though Puerto Rico may be in a crisis now, it never really recovered from the last one a decade ago.
Just look at the big bank stocks to see what I mean.
First Bancorp (FBP) shares collapsed in 2005. They kept falling through 2009. Since then they’ve fallen even more. They’re now down more than 99% from 2005 highs.
OFG Bancorp (OFG) isn’t much better. Its shares fell 65% in 2005 alone. They went on to fall a total of 94% between 2005 and 2009. They’re still down 73% from past highs too.
Finally, Popular Inc. (BPOP) shares dropped 95% from their highs in 2005 and 2009. And they’re still down 87% from those highs.
That’s how bad the crisis was and still is.
Can Puerto Rico really be entering a systemic collapse after it never really recovered from the last one?
But that’s just a bit of history. Some other indicators give us similar clues.
Take a look at Puerto Rico’s government bonds.
Right now Puerto Rican government bonds have sold off a good bit. They’re trading at six-year lows.
That’s not as bad as it sounds though.
The 10-year chart of the S&P Puerto Rico Municipal Bond Index shows had “bad” the sell-off has been (source):
It’s bad. But it’s hardly a crisis at this point.
In fact, the crisis is largely priced into the market.
Peter Hayes, head of municipal debt for multi-trillion dollar asset manager BlackRock, recently told Bloomberg, “They have all this debt that they can’t afford. How do you get out of debt? You either grow your way out -- they’re not growing -- or you restructure. So from the point of view of its citizens, it’s the best outcome.”
Restructure means resetting the price.
At this point, the market is expecting Puerto Rico debt to take a 40% haircut. And Puerto Rico bonds are trading at around 60 cents on the dollar.
Finally, Puerto Rico was hardly a high-quality credit risk before all this began.
Earlier this year Puerto Rico issued new two-year bonds. The interest rate the bonds carried was 8.25%.
That’s a rate paid by third-world countries which have to pay such high rates to offset the risks of the inevitable and predictable debt defaults and restructurings they will go through.
One Rule As An Investor
Clearly, not much of this is a surprise to investors willing to lend money to Puerto Rico.
Most -- if not all of this -- was predicted by major investors who would be directly affected by it.
It’s clear the lessons of the 2008 financial crisis are still fresh in their minds as I’m sure it is in yours and mine as well.
That’s why the next crisis, whatever it may be, is rarely ever caused by the same problems which caused the last crisis.
For a crisis to be a true crisis, it must be a surprise to most investors.
The managers who follow the trillions of dollars in the government debt markets closely watch the risks.
Now, when the point comes when they quit identifying and caring about the risks, that will be the time a debt crisis in Puerto Rico or anywhere else could have a major effect on the rest of the world’s financial markets.
The way it looks right now, that’s just not the case at all.