Why the Law Can’t Protect Your Money
Personal_Finance / Scams Oct 11, 2019 - 07:46 AM GMTBy: Rodney_Johnson
I’m tired of the impeachment talk and it hasn’t really started yet. With the House working on impeachment inquiries in several committees, we’ll get a healthy dose of political doublespeak from everyone involved for at least the rest of this year. It’s already started to crowd other stories out of the news cycle.
But we have to pay attention, because other things are happening that will directly affect us in the months and years to come.
We got a glimpse of our financial future at the end of last week when the first reports about Puerto Rico’s proposed financial settlement came to light. It’s not finished, but we know two things: The law will be ignored, and investors will get crushed.
Get used to it, this is our future.
The Coming of PROMESA
Puerto Rico is arguably the worst financially managed state or territory under U.S. jurisdiction. After gaining independent budget authority from Congress in the early 1980s and promising to be responsible, the island found itself $129 billion in the hole. That includes a pension system with $50 billion in liabilities and assets of exactly nothing.
There’s no provision in the law for a state or territory to go bankrupt. They can only cut expenses (services and pension payments) and raise taxes to make good on their obligations. The Puerto Ricans didn’t like those options, so they went to Congress and asked for a pass. Congress gave them PROMESA, a law that allowed Puerto Rico to pursue bankruptcy in all but name. And it came with an oversight board that can impose its will on the island government.
The creditors lined up and showed their claims, and then pointed to the Puerto Rican Constitution, which clearly states that bondholders are to be paid first. Not after state workers, not after pensioners, not after any other line item in the Commonwealth’s budget.
The Puerto Rican Constitution’s Article IV, General Provisions, Section 8, reads:
In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.
Investors are Taking the Fall
Given the clear directive in the document, you might think the government is paying bondholders and that they stand to get a hefty percentage of what they’re owed. Of course, that would be wrong.
In the plan just released by the PROMESA board, the general obligation bondholders, those with a claim on the full faith and credit of the Puerto Rican government and who can claim a constitutionally guaranteed right to payment, will see their investments slashed by 66%. That’s not down to 66%, this investor class will be left with just over one-third of the original money lent.
Pensioners, those counting on the empty bucket that the government used to pay for other things for decades, will see their payments cut 17% overall. With most of them getting more than 90% of what they are due.
This Will Only Continue
There are no good answers here. For decades, politicians borrowed too much and put too little into pension fund accounts. But there’s no method for reaching back to those individuals to make things. And the Fed hasn’t done anyone any favors.
The ultra-low interest rate environment has killed pension funds on both sides of the ledger. Their fixed-income earnings are lower as yields fall, and the present value of their liabilities has shot to the moon. They earn less and owe more.
The bill came due for Puerto Rico, and true to the nature of man and government, the rally cry is, “The law be damned! What about the people?”
Illinois pension funding sits at 38%, while New Jersey has just 36% of what it needs. The worst is Kentucky, at a mere 34%.
When the day finally comes that these states can’t make good on their obligations, they’ll demand that the federal government set up a structure that allows them to renegotiate their debts. Those are not-so-veiled code words that mean cram down bondholders.
As for Puerto Rico, there is one group of winners: those who invested in identified streams of revenue, such as university bonds and water authority bonds. Because the monies weren’t comingled into a general fund, and the sources of revenue are clear, investors still get what they’re due.
We’ve seen this movie before, in Detroit. And we’ll see it again soon in Chicago.
The situation brings the old Ronald Reagan quote to mind, “Trust, but verify.” A government might say they will pay you back, and even show you the legal contract, but it’s your job to verify that the stream of money is sufficient to the task .
If not, you might just end up with nothing but empty promises, because we’ve seen time and again that the law will not be followed.
Rodney Johnson
Follow me on Twitter ;@RJHSDent
By Rodney Johnson, Senior Editor of Economy & Markets
Copyright © 2019 Rodney Johnson - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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