Must-know analysis: Is Puerto Rico another Detroit in the making?

Market Realist

A Puerto Rican default: Its effect on the municipal bond market (Part 6 of 9)

(Continued from Part 5)

The chart below shows the debt amounts outstanding for certain U.S. municipalities at the time of their bankruptcy. Puerto Rico, though cannot declare a bankruptcy, is under a debt of $70 billion.

Puerto Rico’s current situation does remind us of the time Detroit had filed for bankruptcy. Both share certain common characteristics in terms of the financial situation they landed themselves into. However, the key difference between them remains—Detroit, the most populous city in the U.S. state of Michigan, could file a bankruptcy, while Puerto Rico, being a U.S. territory, cannot declare bankruptcy, even though it may be treated like a state.

Till date, Detroit’s filing for Chapter 9 bankruptcy on July 18, 2013 is the largest municipal bankruptcy in the American history.

The decline or recovery of a municipality is directly reflected in the performance of funds that are invested into it. The iShares National AMT-Free Muni Bond ETF (MUB) tracks the performance of the investment-grade segment of the U.S. municipal bond market through its underlying index. One may also want to compare the performance of the municipal funds vis-à-vis corporate bond funds like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), which tracks the performance of 600 highly liquid investment grade corporate bonds, including General Electric (GE), Verizon Communications (VZ), and Apple (AAPL).

The commonalities

Pension

At the time of its bankruptcy, the city of Detroit had just 9,700 workers, yet it had 21,000 retirees drawing pensions. The city had unfunded pension liabilities of $3.5 billion. This is quite similar to Puerto Rico, which has a large proportion of retirees leading to an amount equivalent to $36 billion in unfunded pension obligations. The commonwealth is currently rebalancing these obligations to make ends meet.

Unemployment

Detroit’s unemployment had tripled in 2012 compared to 2000, with a whopping 18.3% as of June, 2012. This was more than double the national average, at that time. Puerto Rico is also facing an unemployment rate, as high as 15.4%, along with intellectual capital leaving the island in search of better jobs.

Public debt

Detroit’s long-term debt was estimated to be between $18 billion and $20 billion. Puerto Rico has a $70 billion amount in public debt, which has recently been downgraded to junk level by S&P.

Crime

In 2012, Detroit had the highest violent crime rate of any U.S. city with a population over 200,000. The overall crime rate was five times the national average. Similarly, Puerto Rico is currently facing a situation where, due to the rising cost of living, pervasive crime is on the rise.

Continue to Part 7

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