Another Sovereign Debt Crisis
Detroit isn't legally bankrupt yet. U.S. Bankruptcy Judge Steven Rhodes will make the crucial call on whether the city of Detroit is officially eligible for Chapter 9 bankruptcy protection after a series of court hearings starting today. Lots of novel legal arguments from lawyers for claimants to the city's meager reserves will be heard. None is likely to prevail - “if there’s ever a city that needed Chapter 9, it’s Detroit,” said Kenneth Schneider, a Detroit bankruptcy attorney not directly involved in the case. Judge Rhodes is widely expected to agree, in a legal ruling, by the end of this month.
Other government authorities in America, at many levels, are watching closely. One of those is the Commonwealth of Puerto Rico. (This is a Caribbean island that, politically, elects a bicameral legislature and Governor, but as a territory of the United States is subject to US Congressional legislation pertaining to many fundamental aspects of Puerto Rican life.) The Commonwealth's issue today is, like so many other public entities, its debt - $70 billion in an economy valued at just over $100 billion, with an unemployment rate of 14%, and still in recession. From the day that Detroit filed for Chapter 9 in July, municipal-bond investors, who had gorged on Puerto Rico debt (given its triple-exempt status from federal, state and local taxes), have been selling, driving yields on the Commonwealth's bonds as high as 10%. (As a perspective, Greek 10-year bonds are currently yielding 8.4%.)
So of course a crisis in Puerto Rico has been reached. Government officials are meeting today with investors in an attempt to avert at least a credit downgrade by S&P and Moody's, at worst a collapse of investor confidence in the Commonwealth's ability to repay - and hence default.
Companies whose business is to insure municipal bonds - specifically MBIA and Assured Guaranty, who, together, are holding some $11 billion of Puerto Rican bond insurance and are also exposed to Detroit's bonds - are also under S&P's scrutiny. If these companies' credit risks are downgraded, then the issue of systemic risk throughout the municipal bond market becomes front and center. Hardly what America needs as its federal government faces the consequences of its own spending profligacy and political dysfunction.