Per a reader's request, today we'll talk about the impact of the current debt crisis in Puerto Rico. Not only is this a major issue for the Puerto Ricans and their investors, but it also sheds light on how similar crises are likely to play out in the future.

You might want to pay attention to this movie, because you will be seeing it again over the next several years—probably more than once.

Just another bankruptcy . . .

To summarize the situation, the Puerto Rican government (along with associated entities such as the utility companies) has been borrowing money for decades, racking up a total debt beyond what current revenues can support. After several rounds of negotiations between the government and its creditors, a unilateral declaration was made that the government would suspend all payments. As you might imagine, this development has captured everyone’s attention.

Such a massive default—the total debt amount is around $72 billion—is almost unprecedented. Ditto for the government’s decision to stop payments. And yet, the markets aren’t panicking. Why?

First off, this has been a slow-motion train wreck, and everyone saw it coming. Second, there is no real systemic impact. Under current proposals, investors will take a haircut—a 26- to 28-percent loss on general obligation bonds, and a 43-percent loss on sales-tax bonds—but the island will continue to operate and to pay the remaining portion of its obligations. The loss to investors, of around $15 billion, is substantial but not systemically threatening.

Although this is big (and somewhat unusual, given Puerto Rico’s unique legal structure as a U.S. territory), it’s still just another bankruptcy and restructuring. The markets have seen it before and will likely see it again.

Lessons learned

The interesting part about the Puerto Rico crisis is what it tells us about the future. Many U.S. municipalities and even states are in similar positions—or even worse. Bankruptcies may be too strong a word, but expect to see multiple restructurings over the next decade or two. Lessons learned today should be valuable to municipal bond investors then.

So, what can we take away?

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