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Money from misery: How shadowy bond investors perpetuate Puerto Rican poverty

More than 70% of US Municipal Bond holders are exposed to Puerto Rican debt, in excess of $1 billion. Operating in an environment with no oversight or regulation, this powerful group of private investors do not want any default on their bonds and expect a return of 100% or more. There is a dawning realisation within the White House that Puerto Rico cannot simply be abandoned like a failed Casino. Yet again, we see the way in which pure unregulated capitalism is creating unmitigated misery.

Illustration by Rachael Bolton

News hasn’t been quite the same since Donald Trump took office. That’s not meant to be a clever understatement, even it it may appear to be so. The President’s lack of PR stage management facilitates us getting in closer to the concerns of big government than has been allowed for a very long time. What Trump does that disarms people is he tells the truth about the situation in the now. It’s all too easy to get hung up on his embellishments of the past or his superlatives and soporific speech pattern, but listen in carefully and you’ll find that behind his off-the-cuff remarks there are pointers to the real conversations taking place behind closed doors.

The most recent of these barbs that caused shock amongst the liberal press was the “joke” made with regard to the damage caused to Puerto Rico by Hurricane Maria:

“I hate to tell you Puerto Rico, But you’ve thrown our budget a little out of whack.”

Therein lies the truth. This is a corporate response to the situation. There’s a dawning realisation within the Whitehouse that Puerto Rico cannot simply be abandoned like a failed Casino. The latest public statement with Trump mocking a Spanish accent when pronouncing “Pueeertooo Riiicooo”, as excruciating as it may be to watch is a further sign of the annoyance the leadership has that the are going to have to dig into funds they don’t wish to.

Make no mistake, this administration set out with the aim of showcasing fiscal responsibility, so as estimates of costs to repair the damage hover around the $90 billion mark it’s clear to see that Maria has revealed far more than many in the corporate world would like you to know.

Excerpts from the Sound of Music:

How do you solve a problem like Maria?
How do you catch a cloud and pin it down?
How do you find a word that means Maria?
A flibbertigibbet! A will-o’-the wisp! A clown!

Puerto Rico is chronically indebted, and this starts long before Hurricane Maria. Nestled out of sight and out of mind, the jarring poverty of the island is unknown to most Americans. Yet Puerto Ricans are Americans. Decades of mismanagement have seen debts on the Island grow to around the $120 billion mark, (including pensions).  Since 1973, debt bonds have been issued using a little known mechanism that makes them attractive to Municipal Bond Investors, namely the Jones-Shafroth Act which makes the bonds triple tax exempt. In 1984, Congress forbade bankruptcy, and again in May 2017, bankruptcy protection filings were made following the expiry of the PROMESA debt moratorium put into place by Barack Obama in June 2016.

What has made the situation on Puerto Rico deteriorate so fast has been a perfect storm of financial austerity and loss of inhabitants. A debt-to-GDP ratio of 68% means that hardly any monies collected on the island can be used to fund vital public services. After the impact of changes made to the way Puerto Rico was supported by the US with tax subsidies in a 10 year transition brought into effect by the Clinton Administration, many companies fled the island in 2006 as they no longer had tax advantages. As the companies disappeared, so did many of the Island’s highest earners, creating a further erosion of the tax-base and further concentration of poverty as unemployment soared. Those who could get out, did so. Just before the financial crisis of 2007, together with the highly dubious debt issuance experts of Banco Santander, UBS and Citigroup, the Government issued bonds to refinance the debt.

Quite what happens to Municipal Bonds remains a mystery to most of us – largely we go through life not thinking about who profits from misery, yet a humanitarian crisis such as the one currently being witnessed on Puerto Rico brings that into sharp focus.

According to a report issued in 2014, more than 70% of US Municipal Bond holders are exposed to Puerto Rican debt – this powerful group of private investors do not want to see any default on their bonds.

Investors such as the Baupost Group which, under Investment Manager, Seth Klarman, holds over $1 billion of Puerto Rican debt, as recently reported in The Intercept.

Yet again, we see the way in which pure unregulated capitalism is creating misery as investors insist on payback at par (100%), despite having picked up bonds at a discounted rate due to their value being downgraded.

There is no oversight for this kind of deal, no authority who can regulate this and usually, because it’s largely invisible, the suffering goes on in silence.

Management of Public Debt is a moral issue. When generational debt is stacked up on the shoulders of a population with no hope of recovery, tax advantages aiding competitiveness are removed, the population flees and austerity measures are imposed, there is simply no hope for the inhabitants of an Island like Puerto Rico. Add in a Hurricane destroying all power systems and it’s clear that the US will have to step in to help its citizens.

Whilst the damage caused by Hurricane Maria and the ensuing humanitarian crisis is an unmitigated disaster, the focus of attention does at least mean that the Island can no-longer be ignored. CBS struck a nerve in the US. The fact that all power and communications were down, the TV coverage delivered by reporter, David Begnaud, has taken on major importance. Puerto Rico desperately needs help, and the position that Municipal Bond investors take can no-longer be hidden away in shell companies – Maria may have far further reaching implications for the financial markets than anyone expected.

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