It seems that the colossal fiscal problems of Greece have migrated from a financial only to a general news story as the crisis has reached epic proportions. Over the last five years bailouts and austerity programs haven’t done the trick to help Greece pull out of their woes.
Today an Up or Down vote by the citizens of Greece will determine if they are going to accept or decline new austerity measures, stay in the European Union and continue using the Euro as the Greek currency. There are many economists and financial pundits that have varying degrees of prognostications on what will happen if it is a Yes or No vote. Generally, the biggest fear is that it will spill over into other parts of Europe (i.e. Portugal, Italy and Spain) as well as emerging markets. If this occurs, then the potential for a large economic adjustment increases.
What’s interesting is that on the periphery is the Puerto Rican fiscal situation. This past week the governor of Puerto Rico, Alejandro García Padilla, declared that the Commonwealth’s debt of $72 billion is not payable. When comparing this amount to Greece, Spain or other troubled nations, the sum owed by Puerto Rico is much less. However, President Obama stated this past week that there won’t be any bail out of Puerto Rico from the US taxpayers.
The situations in Greece and Puerto Rico were both caused by the same circumstances. There was the lack of revenue from a failure to collect taxes due, corruption, a poor economy and an entitlement system that was impossible to fully fund. These aren’t issues that just appeared out of nowhere. They have been amassing over time and all they needed was one period of economic dislocation to push them overboard. The crisis of 2007-2011 did just that.
While I have not purchased Greek debt directly, my clients owned Puerto Rican municipal bonds a number of years ago. Fortunately when the rumblings started to occur back then, I unloaded the bonds and redeployed the capital elsewhere. It looks like a smart move. Many Puerto Rican bonds are being offered at what would be exceptionally attractive interest rates in today’s environment.
The Greek and Puerto Rican episodes make me exceptionally cautious when purchasing single issue fixed income. I am fully aware there are some things beyond your control so there will always be an unknown risk. Even investing in an ETF or mutual fund may not shield you from exposure to problems in a state, country or part of the globe which has a higher than normal degree of risk.
On June 30th, CNBC ran a story highlighting the top-20 mutual funds that own Puerto Rican debt. Amazingly well respected investment houses Oppenheimer and Franklin Resources (i.e. Franklin Templeton) own approximately 10% of the entire $72 billion in debt according to the Wall Street Journal.
Apparently even the big houses were caught blindsided by the Puerto Rican catastrophe. Fortunately for many of them and the banks of Europe, the IMF and ECB purchased much if not all of the Greek debt over the last five years.
One has to assume that there are similar situations to what is occurring in Greece and Puerto Rico in other municipalities, states, countries or regions. The next question is “where are they”? While this is all conjecture it might be worth taking an educated guess as to where the next debt problems might occur.
Conventional wisdom would say that cities such as Chicago, parts of California or entire states like Illinois or Michigan are next. They have been in the news more frequently lately as those next in line for debt problems. Issues such as a declining tax base, a growing social safety net, promised retirement / healthcare benefits to civil servants and squandering rainy day funds or misallocating windfalls from such things as the tobacco settlement have all exacerbated the problem. However, as an investor you must realize that these problems aren’t confined to just the areas listed above.
Instead, the problems could occur in small-to-mid-sized towns, cities and counties where the problems already highlighted or just simple quality of life issues such as warmer / nicer weather could create issues. Whatever the rationale, the end result is an increased risk of default for once “safe investments”.
The best way to potentially mitigate your risk is to define your tolerance, income needs and assume that unforeseen random events may occur which you may not have considered just seven to ten years ago. If you believe the task is daunting it might be best to hire a professional adviser that can analyze and advise you on which issues will be suitable for your needs.
If you have any questions or comments regarding this blog or any other thought, please contact me at firstname.lastname@example.org. Thanks for reading!!!
Source: CNBC and Wall Street Journal from June 30, 2015
Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.