PMC Weekly Review - September 29, 2017

A Macro View - Puerto Rico: The Aftermath

Hurricane Maria made landfall in Puerto Rico last Wednesday as a Category 4 storm, bringing with it 155 mile-per-hour winds and managing to drop up to 35 inches of rain in some areas of the island before leaving. Puerto Rico’s governor, Ricardo Rossello, described the storm as the “most devastating storm to hit the island this century, if not modern history.” So far, the storm is estimated to have caused at least $30 billion of damage to the US territory.

Now that the storm has passed, the humanitarian effort is clearly the paramount concern, as the entire island has lost power, many of the island’s residents still cannot access clean water and communication, ports, and other infrastructure critical to the welfare of Puerto Ricans is inoperable. However, the fact that the island’s economy was already fragile before Hurricane Maria arrived is further compounding the recovery effort. Puerto Rico is in the midst of a massive debt crisis caused by mismanagement of public funds and pension obligations, coupled with a struggling economy and an exodus of many of the island’s residents.

During the past couple of decades, tax breaks on the island dried up, and the Puerto Rican government initiated new bonds backed by a sales tax, to support the island’s aging infrastructure. However, due to mismanagement and a dwindling tax base, the island now owes more than $74 billion to bondholders and roughly another $50 billion in pension obligations to the island’s teachers and government employees. Particularly concerning, the Puerto Rico Electric Power Authority (PREPA), the government-owned power authority tasked with restoring power to the island in the wake of the storm, itself owes more than $8 billion of the aforementioned $74 billion. The territory’s debt situation has been a long time coming and has been compounded by persistent high unemployment and a declining manufacturing sector. This has driven many of the island’s residents to move to the US mainland, limiting the island’s population (and maybe more importantly, its tax base) to only 3.4 million people today. In an attempt to improve the situation, Congress created an oversight board last year to manage the island’s finances and filed a bankruptcy-like case in May in an effort to drastically reduce the island’s debt.

Then Hurricane Maria visited Puerto Rico, which only compounded these looming problems. Clearly, these events add more uncertainly to the island’s ongoing bankruptcy proceedings. Not only is it unclear from a timing perspective how those proceedings will progress, but it also raises a concern as to whether these events will cause the island to have additional insolvency problems. With massive devastation to much of Puerto Rico’s infrastructure, it seems likely that future spending will be directed first towards rebuilding that infrastructure before any payments are made to bondholders. In fact, the Federal Oversight Board has already allowed the island to divert $1 billion towards the cost of recovery. Furthermore, the storm likely escalates the migration of island residents to the US mainland, probably bolstering a trend in which the US Census Bureau was already expecting a further 11% decline in the island’s population by 2025.

It is clear that federal funding will be critical to rebuilding Puerto Rico. Expenses after a natural disaster such as this can be a massive cost at both the state and local levels, but the federal government traditionally has stepped in and assumed most  of the expenses for these types of rebuilding efforts. However, states or municipalities typically exhaust their own funds before any federal assistance comes their way. Obviously, Puerto Rico doesn’t have much money on hand, so the US Federal Emergency Management Agency’s (FEMA) timeliness in dispensing funds to the territory will play a major role in how quickly Puerto Rico can recover and how that will affect its existing economic crisis.

Swiftly rebuilding after such a storm is essential to maintaining Puerto Rico’s tax base, which is already fleeing. However, the hurricane also has paused the island’s bankruptcy process, as a team of judges has already delayed the proceeding indefinitely, which only places more scrutiny on bondholders of the island’s debt as their investments are clearly in peril.

Human welfare is obviously the critical concern at the moment and fortunately aid is on the way via FEMA’s provision of grants for such items as temporary housing, home repairs, low-cost loans for property losses, etc. Additionally, 4,000 members of the US Army Reserves have been deployed, and Congress is lobbying to send a second supplemental disaster package to help aid hurricane zones. Unfortunately, it is clear that Puerto Rico will continue to be plagued by deep structural problems. Clearly, the effects of the storm and the growing fiscal situation will continue to weigh on the tropical island’s population and darken its economic fortunes for the foreseeable future.

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Source: Bloomberg

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