Puerto Rico Bondholders: Fact and Fantasy
When I think about "bondholders," I tend to think about their lawyers. (That probably says a lot about the crowds that I run in). In the case of Puerto Rico, we've seen affable, whip smart, expensively dressed New York lawyers make cogent arguments against many of the bond restructuring proposals. But these lawyers are not the bondholders themselves, who are a much more diverse lot. While the hedge funds may be voicing many of the arguments via their fancy attorneys, there is a large, and and largely silent, bondholder community of Puerto Rican residents. The number that I've seen for the share of bond debt held by residents is 40%, although it is difficult to validate this, and it almost surely varies depending on the bond issuer, bond vintage, and other factors.Thomas Mayer estimated to Congress that $15 billion in PR bonds are held by Puerto Ricans, a lower figure than the 40% share, but the dollar figure is still hefty.
In the public debate about Puerto Rico's fiscal crisis, people have noted that the debt is widely held across the country--that this is not "just" a Puerto Rico issue. PR bonds were given tax-advantaged status, regardless of the bondholder's place of residence. But that does not mean that residents of Puerto Rico themselves--for either fiscal or civic reasons--are not an important group of bondholders. Their concerns about a bond default and willingness to restructure may be quite different than hedge funds or institutional investors. Why? And how might this affect the Administration's interest--or taxpayers' interest generally--in a workout for bondholders.
By nearly every measure, Puerto Rican residents have poor financial health. The unemployment rate is above 15%, more than double the 7.3% in the mainland, according to the Bureau of Labor Statistics. The poverty rate, according to the 2013 Census, was 44.9%--twice the rate of perennial front runner, Mississippi. Puerto Rico also faces a serious labor drain. In each of the recent years, about 55,000 residents migrated the mainland. Much of this is driven by Congress' phase out of Section 9316 of the U.S. tax code, which had exempted profits earned by American companies from business conducted in Puerto Rico. As a result of a more modest tax credit, the number of manufacturing jobs on the island dropped by almost half between 2006 and 2014. And this being Credit Slips, I want to also give a bankruptcy stat. In 2014, Puerto Rico was the only one of the 90 judicial districts that had an increase in bankruptcies.
If the overall financial situation of Puerto Rico collapses, the local government will have an even harder time providing social supports for residents. It would be a double whammy for residents who held bonds. They would take a haircut on repayment that could impact their incomes or retirements, and see cuts to services and resources that could further cripple their economy. It could also be a double whammy for the U.S. Treasury and taxpayers. Puerto Rico already received billions of dollars for Medicaid and other programs. One option floated is to condition any continued funding from the U.S. Treasury to Puerto Rico on its taking certain actions with respect to its bonds and the management of the municipalities that issue bonds. This is a very big carrot (so big perhaps as to be a stick.) My hope is that any options to restructure Puerto Rico's bonds can be paired with long term investments in improving and stabilizing the local economy and improving the financial situations of typical Puerto Ricans living on the island.