Our short answer is: Not much. Greece is still a pimple on the world economy. Nearly all of its sovereign debt is now held by central banks, who can write it off with little lasting effect on world markets. The real issue is the domino effect. What if Italy, Portugal and Spain get the idea that blackmailing the Eurozone for perpetual bailouts is a good gig? What if they follow the lead of Greek Prime Minister Alexis Tsipras?
Last week Tsipras announced that, instead of accepting the onerous terms of the “final” bailout offer from the Eurozone in return for fresh loans, he would hold a referendum so the Greek people could decide for themselves. In the days leading up to the vote, the foreign money flow has stopped, banks and the stock market have shut down, and grocery stores and gas stations have been overrun. The Greek economy is frozen in anticipation. Is Tsipras’ ploy merely a negotiating tactic or is he pushing the limit simply to get the best deal for the Greek people? No one knows.
The Eurozone appears to be dead serious, implying that a “no” vote on the referendum is really a vote to drop the Eurocurrency and return to the Drachma, an outcome which they say would be calamitous for the Greek people. Others say the REAL problems for the Eurozone will start when the Greeks leave the Euro and end up BETTER OFF! Whatever the outcome of Sunday’s vote, we think both sides will find a way to once more “kick the can” down the road. Even if they don’t, Greece itself is not material enough economically to make a difference to U.S. investors.
As for Puerto Rico, basic structural issues and bad incentives (sound familiar?!) have combined to create a slow-motion debt mess, much like Greece. Public payrolls are way too large and wages are way too high relative to output, partly due to liberal wage laws and work rules imported from the mainland.
In addition, a key driver of Puerto Rico’s ability to keep borrowing has been the “triple tax free” nature of their debt. Domestic investors lending to the U.S. territory pay no tax (Federal, State or Local) on their interest. The result is that the island’s fiscal problems have been festering for years. Puerto Rico now owes a total of $72 billion, more per capita than any U.S. state, and the Governor recently admitted that “the debt is not payable”.
Many U.S. mutual funds and hedge funds are stuck with Puerto Rican bonds, and we believe there could be a flight from risk out of these funds. This is likely to create temporary liquidity problems for municipal bonds in general, causing prices to fall. This should be short-lived, however, as investors distinguish between bonds that are truly distressed and those that aren’t.
If a conservator can mediate a plan with creditors and insurers, it would likely contain any further damage. We’ve been warning about Puerto Rican debt in client communications, and specifically at our yearly client event. In summary, we believe the problems in Puerto Rico are potentially more serious for U.S. investors than Greece, but our exposure is minimal.