How Changes in Interest Rates Affect Bonds ?
Interest rates are one of the most important factors while determining the bond value. All other factors like payments, number of periods etc are standard i.e. the numbers supplied to us are the numbers that have to be used in the formula for calculating present value. However, this is not the case with interest rates. […]
Strategies Used by American Companies for Tax Avoidance
America has been the hub of financial and entrepreneurial activity ever since the end of World War 2. However, over the past few years, the number of corporations that are using America as their base has been steadily declining. This is because of the unfavorable tax policies in America. America is the only country in […]
Tax the Rich Policy: A Critical Analysis
There are few issues which strike through the heart of communists in China and capitalists in America similarly. One such issue is the issue of taxes, particularly the taxes that are levied on people of the extremely high income category. The popular opinion is that the rich somehow collude with the politicians to create a […]
Why is Short Selling a Dangerous Financial Strategy?
The term short selling is often seen in the news. This tactic is regularly used by well-known investors. They are also very public about the shares they have shorted. This prompts many retail investors to follow suit. While, it may be true that many funds and high net worth investors make a lot of money […]
Dividend Discount Model: Gordon Growth Rate
In the previous article, we became aware that the value of a stock can be split into two parts. One part is the horizon period i.e. the period chosen by the analyst for which they believe they can accurately forecast the financials of the company and therefore its dividends. This part remains the same when […]
The high indebtedness of the United States of America is well known. However, USA is still considered to be an economic superpower and its economy even in the faltering state is better than many countries. However, of late Puerto Rico, an American state in the Caribbean islands has revealed information that communicates financial distress.
The Puerto Rican governor Alejandro Garcia Padilla has told the media that the $72 billion accumulated by the Puerto Rican government as debt is simply not payable. He goes on to state that the Puerto Rican debt crisis is not a political problem. Rather it is simply a mathematical problem wherein the numbers speak for themselves. Governor Padilla has referred to the recent rising debt figures as a debt spiral that has gone out of control.
This has prompted many journalists to sensationalise the issue and nickname Puerto Rico as a Greece within America since its government has borrowed unimaginable amounts of money without any plausible plans to pay it back.
Puerto Rico has $72 billion in debt. This may not seem much as there are many states which have much larger debt figures in absolute terms. The Puerto Rican population is about 3.4 million people. This means that the per capita debt in the region amounts to an astounding $20,400.
Puerto Rico is not an area where wages are very high. Therefore, the debt amounts to an astounding 69% when compared to the GDP. To put this debt into some sort of context, the average Puerto Rican makes fewer wages than the average American worker but has a debt burden which is over twice the national average!
One argument cited was that since the Puerto Ricans do not have to pay federal income tax they can afford to pay a higher percentage of their income as taxes. However, when the government tried to implement these increased taxes, it faced a mass exodus of people. Many people have left the island and settled in mainland America in the hope of better economic prospects. Hence, the government finds itself cash strapped, struggling to make any payments on its debt.
Credit rating agencies like Standard and Poor’s have projected a very bleak economic outlook for Puerto Rico. This can be gauged from a CCC- rating with a negative outlook that they have given the island state. This rating is the same as what S&P’s has given to Greece. Therefore, in a way S&P does think of Puerto Rico as a Greece within America! To top it up, Puerto Rico does not have the option of filing bankruptcy and therefore is unable to get out of this situation. This is what has prompted Governor Padilla to bring the issue to the notice of the media and create some sort of political pressure.
The Puerto Rican crisis has been created by misguided attempts of the government to benefit the people. The Puerto Rican government, in its bid to create employment started providing extensive tax breaks to many companies. Enticed by these breaks, many companies did set up shop in the island state. The Puerto Rican people got accustomed to good employment opportunities that the presence of multi-nationals brought along!
However, a few years later the Federal government cancelled the special tax breaks that were being given to companies in Puerto Rico. As a result, many companies simply left the state and employment opportunities started dwindling.
The Puerto Rican government took populist measures to control this crisis. They simply started borrowing more and more and spending it to keep the economy afloat. The jobs lost as a result of companies moving out were created because of government’s massive spending on infrastructure. Soon, the Puerto Rican government ran out of other people’s money and found itself in a situation wherein lenders were no longer willing to extend credit on favorable terms and downgrades by credit rating agencies became a routine activity!
The Puerto Rican government has been forced to take extreme steps in the opposite direction in order to make good the loss that it has caused. Thus, all its infrastructure spending programs have been severely rolled back if not downright shut down. This has caused rampant unemployment in the island state. The unemployment rate in Puerto Rico is also twice the national average and hovers somewhere around 14%! Thus, instead of rescuing the average Puerto Rican from economic fallout, the policies of the government have ended up making the effects more severe.
Moreover the taxation rates have been increased on the limited income that is being made by the workers in this island state. The welfare spending has also been negatively affected, and the government is on the verge of complete economic fallout just like the Greek government.
A default by the Puerto Rican government is also expected to lead to hiccups in the sale of bonds by other states to finance their debt. Also, it will end up setting the wrong precedent if America allowed its states to borrow beyond limits and just default on their obligations. How this crisis will be handled by the biggest economic superpower on earth is yet to be seen.
Your email address will not be published. Required fields are marked *
