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 When most people think of Puerto Rico they think of Caribbean sun-washed beaches and salsero music.
   Increasingly, Puerto Rico is instead getting known for it's 15.4% unemployment rate, a murder rate higher than Chicago, and an economy that has shrunk 14% since 2006. This is causing a new diaspora as the population shrinks by 1% a year.

  However, the real economic crisis may be just up the road.

All three major rating agencies cut the bonds backed by the Commonwealth’s taxing power to junk in the past two weeks, which could cause even more price volatility as investors exit the market for Puerto Rico debt. In the last 12 months, Standard & Poor’s Puerto Rico muni index dropped 21.3%, rare losses for the municipal bond market, which is often sought for its perceived safety.
 Puerto Rico is not a small issue. We are talking about $70 billion in debt, which is about 8 times the size of Detroit.
   The problem is that Puerto Rico, unlike Detroit and more like Greece, can't file for bankruptcy protection. Thus Puerto Rico may be caught in the same austerity trap that Greece is part of.
  As you may know, many funds are forbidden by internal rules to own non-investment grade bonds. Thus Puerto Rico's downgrades will not only cause their borrowing costs to rise a great deal, but will also eliminate many of their possible sources for future borrowing.

  So far the markets have mostly shrugged off the danger of contagion from Puerto Rican bonds. However, there could be an unexpected curveball that could upset everything.

 Puerto Rico is already getting what amounts to $2 billion a year in the form of a tax credit from a law that dates all the way back to 1921. That figure alone would “be enough to pay all the interest on their debt for a year” according to Kotok but it certainly hasn’t helped so far.
    If the IRS decides to rescind the $2 billion credit Puerto Rico could plunge into chaos, leaving the 400 some mutual funds across the US that own the territory’s existing debt holding the bag. That’s unlikely to happen, but given the deterioration in the PR economy, even with the subsidy and the credit agency downgrades that continue to drive up the cost of capital for the island nation it’s hard to see how this story ends well.
 As I write this, Puerto Rico is preparing a new $2 Billion bond sale in March, it's first major bond auction since the downgrades. This will be the first real test of market demand.

  The deteriorating economy has caused Puerto Rico's educated professionals to flee to the mainland. This has left behind an older, less skilled population, where already only 41.3% of working-age Puerto Ricans have jobs, 37% of households receive foodstamps, and the average income is half of Mississippi's.

11:45 AM PT: The rating downgrades triggered a more immediate debt problem for Puerto Rico.

 Puerto Rico is trying to refinance debt or negotiate with creditors to avoid making a $940 million payment, almost 10 percent of its budget, after the U.S. commonwealth was cut to junk by Standard & Poor’s and Moody’s Investors Service...

   The moves trigger accelerated payments on debt and calls for increased collateral on swaps. Almost half may need to be arranged within 30 days, said David Hitchcock, an S&P analyst.
 Meanwhile, the White House has so far refused a bailout.
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