Is it possible that Puerto Rico’s bondholders are finally coming to their senses? For a few of them at least, it certainly looks like an overdue change of heart has taken place. And to think: All it took was a Category 4 hurricane that destroyed the island.
t's hardly a secret, of course, that Puerto Rico owes its bondholders far more money than it can ever possibly repay: a staggering $74 billion for an island with population that hovers around 3.2 million. (By contrast, the nation of Argentina, which had a population of 37 million when it defaulted in 2001, owed its bondholders only $6 billion more at the time.)
But while the debt has received a great deal of attention in the three weeks since Hurricane Maria hit — especially once President Donald Trump started mentioning it in tweets — Puerto Rico has been struggling to find a way out of its predicament at least since the summer of 2015, when the government first began defaulting on bond payments.
It’s just that, prior to the hurricane, the bondholders really didn’t care that Puerto Rico didn’t have the money to repay its debt. They were going to demand their money no matter how much hardship it imposed.
After those early defaults, for instance, the holders of the territory’s general obligation bonds, who are owed close to $18 billion, sued, noting that its repayment stream was constitutionally guaranteed — indeed, they were supposed to be paid before teachers and cops. Holders of the electric utility’s bonds tried to force a rate hike so that they could get paid, which, given the Commonwealth’s 44 percent poverty rate and barely functioning infrastructure, can only be described as heartless.
When Congress passed a law establishing a bankruptcy mechanism for Puerto Rico, they fought it. When a temporary halt in litigation mandated by the new law expired early this year, they all dove in with new or renewed lawsuits. The notion that Puerto Rico lacked the means to pay back its debt, and that its citizens lacked the money to make basic infrastructure repairs or run a decent health-care system, seemed not to matter a whit.
Last year, during a court hearing in San Juan, a lawyer for National Public Guarantee Corp., a big bond insurer, perfectly summed up the attitude of the bondholders:
Your Honor, the Commonwealth is literally taking other people's money away. … Literally. … They are simply putting their hand in someone else's pocket and taking that money away. I don't know what more concrete harm could possibly be shown than people taking our money every single month.
On Sept. 26, just days after Hurricane Maria ripped through Puerto Rico, U.S. District Court Judge Laura Taylor Swain, who is overseeing the litigation surrounding the bankruptcy, ordered that the proceedings be temporarily postponed. She wrote:
These Americans, who were in the process of restructuring billions…in the hope of emerging from an economic crisis of unprecedented proportions, now face an even graver humanitarian crisis, one also that threatens their already challenging path back to economic stability.
The focus, she added sensibly, needed to be on getting the "millions of Americans" who live in Puerto Rico the food, water, fuel and basic services they needed.
And still the bondholders didn’t budge.
None of the bondholder groups dropped their lawsuits, including Aurelius Capital Management LP, which had audaciously sued to have part of the 2016 law that established Puerto Rico's ability to seek bankruptcy protection declared unconstitutional. Virtually none even offered a statement of condolence. The Intercept, a left-leaning news organization, polled 51 Wall Street firms that were known to be bondholders, asking if they planned to withdraw their lawsuits. Three — Goldman Sachs, Citibank and Scotiabank — noted that they had contributed money towards Puerto Rico’s recovery: a grand total of $1.25 million. The rest didn’t respond at all.
And then, on Friday, something changed. First, Assured Guaranty Ltd, another bond insurer, dropped its lawsuit against the oversight board’s fiscal plan, citing the hurricane.
“Now is no time to be arguing over these issues, when residents of the island are suffering,” said chief executive Dominic Frederico in a statement. “The current focus should remain on restoration and relief for Puerto Rico.” (The company also noted, however, that it might refile the suit later.)
Second, Dan Fuss, the vice chairman of Loomis Sayles & Co., the mutual fund firm, went on Bloomberg TV and declared that he and his firm had miscalculated the risk that came with buying Puerto Rico’s triple-tax-free bonds. "The reality is that you have a human disaster on your hands," he said. He added that he fully expected that his firm would have to take a haircut — but that wasn’t uppermost in his mind.
"I mean these poor people have enough to worry about," he added, choking up slightly. "They are U.S. citizens. We are U.S. citizens. We have an obligation to help."
That, of course, is how everyone on Wall Street should be thinking.
Did Puerto Rico make mistakes? Sure it did. In its desperation, it signed onto to some truly terrible bond deals. It has pension obligations that on a per capita basis match those of Illinois. It imposed a sales tax on its citizens, and then used it as collateral to borrow billions more.
But the municipal bond funds and hedge funds that bought Puerto Rico’s bonds made big mistakes too. They ignored Puerto Rico’s increasingly dire economy as they bought bond after bond. They clung to paper guarantees even as they became increasingly unrealistic. And they ignored Puerto Rico’s own financial missteps until it was much too late.
Richard Ravitch, the New York businessman and politician who has been deeply involved in Puerto Rico’s debt crisis, recalled for me recently a conversation he had at a meeting shortly after the Commonwealth began defaulting on its debt:
A hedge fund guy came up to me and said, "The government doesn’t even have audited financial statements." I happened to remember that his firm had bought general obligation bonds in 2012. I said, "There were no audited financial statements when you bought the bonds either."
Puerto Rico’s bonds always came with a higher-than-average risk for a municipal bond. Every investor knows that sometimes a risky investment doesn't pay. Bondholders shouldn’t be trying to correct their mistake by litigating to kingdom come. They should accept their losses like big boys and girls. Just as Dan Fuss did on Friday.
The next hearing before Judge Swain is likely to take place sometime in early November. We’ll see then which bondholders keep suing, and which conclude that the best thing they could do is walk away from their lawsuit. That is, we’ll see if there are others on Wall Street who care more about their fellow Americans than about having their loans repaid. I plan to be there.
--- For more columns from Bloomberg View, visit http://www.bloomberg.com/view.