James Spiotto is managing partner at Chapman Strategic Advisors. The opinions expressed in this commentary are his own.
While Puerto Rico may have escaped the worst of Hurricane Dorian, its financial troubles — worsened by Hurricane Maria — continue to complicate reinvestment and rebuilding there. Reducing the cost of financing infrastructure improvements will allow both the Puerto Rican and US economies to grow and prosper.
This starts with a solid financing plan in the United States. Without continued investment, our economy cannot work. The American Society of Civil Engineers predicts that the United States will fall $2 trillion short of its infrastructure investment needs by 2025. Historically, the municipal bond market has filled this gap, which, in the United States, is presently comprised of $3.8 trillion in outstanding municipal debt. But due to Puerto Rico’s fiscal crisis, resulting in bankruptcy-like proceedings after it stopped repaying its general obligation bond debt in 2017, municipal bonds and the infrastructure programs it finances are at risk.The cost of a bond depends on the perceived risk an investor takes in financing a project. A risky municipal bond can lose up to 15% to 25% of the principal amount as additional interest cost. Risk increases when the repayment conditions are uncertain. At the current moment, events in Puerto Rico are casting a cloud of uncertainty over the entire market.In March, a court established by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) ruled — contrary to past bankruptcy courts’ rulings and practices — that municipalities are not required to make payments on special revenue bond debt if they do not want to during bankruptcy proceedings. This sets a dangerous precedent for the municipal market generally. How can investors calculate risk if the government’s willingness to ever pay them back is uncertain?Read MoreMore Markets & Economy Perspectives
Typically viewed as safe and stable investments, this ruling has cast municipal bonds in a more perilous light. And the perceived risk has the potential to make repairing the United States’ infrastructure even more costly. In an attempt to change course in Puerto Rico, PROMESA created the Financial Oversight Management Board. Tasked with establishing fiscal responsibility, enhancing market access for Puerto Rico and helping the island walk back from the cliff of fiscal disaster, the Board has so far failed in its critical mission. The Board recently acted to repudiate $6 billion in general obligation debt (which is traditionally honored by all states without default) and attempted to claw back prior bond payments. Repudiation of general obligation bonds is unprecedented and in direct violation of the Puerto Rican Constitution’s priority in paying public debt.In the absence of robust revenue streams, Puerto Rico has struggled to replace the infrastructure it lost in the hurricanes. If the island is not held legally responsible for repaying its bond debt, including $13 billion in general obligation bonds, the damage to the integrity of the municipal bond market will make it difficult to rebuild its infrastructure. The fallout from this has already begun. After a US district court determined payments on defaulted Puerto Rico Highways and Transportation Authority bonds were voluntary during bankruptcy proceedings, Fitch Ratings put seven US bond ratings on watch for potential downgrades, including the cities of Chicago, Phoenix and Sacramento. This makes borrowing even more expensive and could cause a loss in market value of billions of dollars in bonds. Governments cannot bait and switch when it becomes inconvenient to pay what was represented and relied on at issuance as valid, legal bonds. Setting such a precedent makes it extremely difficult for creditors to enforce contracts and for governments to obtain financing. These actions could make it more expensive for all US state and local governments to pay for infrastructure investments. Everything from schools to sewer systems, seaports to highways and even hospitals would be affected.We don’t have a functioning economy if we do not have the practical tools to support it. We have to preserve the municipal bond market — our future and that of our states and nation depend on it.