Pensioners Versus Creditors

Puerto Rico is facing a financial crisis that is likely to pit the interests of creditors against those of public employee pensioners.  Puerto Rico is currently believed to have about $72 billion of financial debt outstanding, most of it in the form of municipal bonds.  Concurrently, the employee pension system is nearly out of money with an estimated $43 billion in unfunded pension liabilities.  Yet some 330,000 people are depending on this pension system.

Clearly, Puerto Rico can’t pay everyone.

A broad plan being put forward by the U. S. Treasury to ease the island’s financial crisis would put pension payments to retirees ahead of payments to bond holders.  Clearly the moral high ground.

There are many causes for Puerto Rico’s financial problems, and out-migration is considered to be a major factor.  This is not dissimilar to problems facing many of the mainland’s major cities as declining populations have reduced property values and tax collections.

An added complexity in resolving Puerto Rico’s financial problems is its status as a United States territory, and as such, has no access to bankruptcy laws, where complex claims by various creditors can be worked out in a court under the supervision of a bankruptcy judge.  This was how Detroit’s bankruptcy was resolved, with relatively modest hits to various classes of pensioners and significant losses by lenders.

This is not the place to assign blame or dwell on the whys of the problem.  However, any solution to Puerto Rico’s financial problems that favors pensions at the expense of bond holders should be a further wake up call for municipal bond investors.  Prospective purchasers and current owners of municipal debt should, together with their advisor(s), be particularly vigilant in assessing the financial strengths of municipal bond issuers.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®