By David Dayen, a lapsed blogger. His book, Chain of Title: How Three Ordinary Americans Uncovered Wall Street’s Great Foreclosure Fraud, releases in May. Follow him on Twitter @ddayen
Happy New Year! And now, back to the misery. The commonwealth of Puerto Rico opened 2016 with their second debt default in as many years. Having followed this issue for several months, I always find it difficult to discern just what was defaulted and what was paid out. CNBC claims that 2 of the 13 scheduled bonds due today went unpaid; $35.9 million to the Puerto Rico Infrastructure Financing Authority (PRIFA) and $1.4 million to the Puerto Rico Public Finance Corporation. But the Times says the island defaulted on “$174 million in debt payments,” even though it refers to the same two bonds. The byzantine rules around what constitutes a default accounts for the discrepancy:
With big bond payments looming, (Puerto Rico Governor Alejandro) García Padilla announced last week that he had ordered a “clawback,” or recovery, of cash that would have normally been used to pay certain bonds. Since Nov. 30, he said, that cash had instead been diverted to help make a $328 million payment to the island’s general obligation bondholders, who are entitled to be paid first, according to the Puerto Rican constitution […]
The clawback allowed the government to amass enough cash to pay the general obligation bonds, which enjoyed a price rally on Monday.
But it put the other bonds into default, the governor acknowledged. In some cases, bondholders could still be paid out of prepaid reserves, but drawing on a reserve without replenishing it is also considered a form of default.
And in the case of bonds issued by the Puerto Rico Infrastructure Financing Authority and the Public Finance Corporation, there were no reserves. The responsibility to make the payments would then fall to bond insurers.
At least one bond insurer, Ambac, freaked out amid the news. Their stock has been falling since last week when the announcement was first made. $37.3 million in bond insurance payouts is one thing, but if this becomes a habit, the monolines simply don’t have the reserves.
The clawbacks come from a stream of revenue generated by the excise tax on Puerto Rican rum, which ironically was just extended until the end of 2016 in the end-of-the-year tax extenders deal. Without the extension, the territory would only receive $10.50 per proof gallon; with it, they get $13.25. The bad news for Puerto Rico is that, without the big ticket items like the R&D tax credit and others to anchor a tax extenders bill, it’s likely that was the last extension, meaning expanded rum tax revenue only has about another year left before reverting back. And that might not be the only revenue source: there are rumors of raids to the public employee pension fund.
There’s an assumption that the island is lying about its cash on hand to try to get out of repayment, but the money is actually coming from the citizens (they’ve stopped repaying tax refunds too, for example). The outrage over paying Christmas bonuses to public workers, which are part of their salary agreement, is a good example of the built-in biases here. Yes, all the debts can be repaid, as long as the people suffer. And while past Puerto Rican governments deserve a ton of blame, there’s a very explicit agenda here.
Interestingly, the first default, on $54 million of the same Public Financing Corporation bonds in August, didn’t trigger much of a stir, legally speaking. Now the threats of litigation are apparent. The question is who will sue, the bondholders or the insurers? I’d guess the latter. The constitutionally-obligated debt did get paid through extraordinary measures, and these PRIFA and PFC bonds have less protections for bondholders. Moreover, with the GO bonds rallying, anyone invested in both would take their insurance on the lesser bonds and payments on the greater ones. It’s Ambac making the stink about violations of due process and the takings clause of the Constitution, to say nothing of island law.
Meanwhile, PRIFA bonds traded as low as 9 cents on the dollar (for context, GO bonds are trading around 73 cents), making them targets for vulture funds to scoop up. One complicating measure for that is the recent loses in the junk bond market, hurting precisely the same funds with vulture strategies, like Stone Lion, which is active in Puerto Rican debt and also recently closed down one of its junk bond funds. But 9 cents is extremely attractive; even if PRIFA bonds have fewer protections, it will still prove difficult for the commonwealth to completely obviate the debt.
Reading the press, you get the sense that creditors and analysts think Puerto Rico is bluffing. They’re mostly paying the bills while using the small defaults to force Congressional action, the theory goes. Of course, the island has a bad hand to play in court, so paying as much as possible is just rational. And the defaults will only grow; $2 billion in payments are due in July, twice as much as this round, with hundreds of millions before that. Without new relief from the debt markets or the bankruptcy courts, the money just isn’t there.
As for Congress, the House will hold two hearings next week. Paul Ryan has nominally agreed to some form of assistance for Puerto Rico by the end of March. But the cure is likely to wind up worse than the disease; there has been talk of using the New York Fed as a “technical advisor,” and their plan is basically to beat the island into submission.
The tentative agreement on restructuring debt from the electrical authority, after a year-plus of negotiations, may lead some in Washington to think that the entire $70 billion problem can be settled without the bankruptcy courts. That’s just highly unlikely, especially because the GO debt is so constitutionally protected that there’s no incentive for bondholders to give an inch.
Pretty much everything I’ve wanted to say about Puerto Rico is in this longform piece at The American Prospect last month. This is a slow-motion disaster, with a lot of cultural biases about Latinos scheming to get out of their debts and lying about their cash balances. It’s all very unsavory, and in service to transforming the island into a tax haven playground for the wealthy.