Ignorance Can be Better than Bliss

ilene's picture

Ignorance Can be Better than Bliss

By Paul Price of Market Shadows

Common sense suggests that reading esteemed financial publications and major brokerage house research reports would help you make good decisions. However, in many situations it leads to exactly the opposite result.

Most people don’t have the ability and resources to evaluate individual muni bonds. They count on their brokers or financial advisors to steer them into appropriate issues while relying heavily on rating agencies’ bond quality designations.

The handling of Puerto Rican (PR) tax-free bonds provides a perfect example of how the reliance on financial publications, brokerage houses and rating agencies resulted in bad timing and avoidable losses.  

PR’s bonds had previously been widely recommended. Their coupon rates were higher than most other issuers and they offered tax-free treatment in all 50 states. Until recently, Puerto Rican general obligation (GO) bonds had been rated highly enough that debt holders believed they could expect to be paid back principal plus interest as promised.  

[A general obligation bond is a common type of municipal bond in the United States that is secured by a state or local government's pledge to use legally available resources, including tax revenues, to repay bond holders (Wikipedia)]

Brokers sold, and individuals bought, PR munis at prices reflecting S&P, Moody’s and other ratings that falsely conveyed a rosier-than-real picture of that government’s ability to repay.  The last remnants of that fantasy ended when Barron’s Aug. 2013 cover story belatedly broke the news that bond trading firms already knew… PR was in serious financial trouble.

 PR in Trouble  - Barron's Cover

Spreads on Puerto Rico’s 10-year paper had already shot higher, pushing prices on existing PR bonds lower. The Barron’s story led to panic dumping and even lower resale prices for investors wishing to exit their positions.

10-year PR GO spread chart

Half a year later, on February 4, 2014, ratings giant Standard & Poors also admitted what had been painfully obvious. They downgraded Puerto Rican GOs to junk status. This came only after severe damage to holders of older PR bonds. Spreads versus investment grade paper had ballooned from under 3% to about 7.5%. Way too late to help anybody, Moody’s finally joined in the downgrades too. 

 Rating Agencies downgrade PR bonds

Between August, 2013, and last week, many bond holders, scared by the new reality that wasn’t really new, sold at horrible prices to avoid possible defaults. They felt compelled to unload them. PR paper had now been officially deemed ‘too risky for conservative accounts’.

The same brokerage firms that had originally touted the bonds as good investments were advising clients to sell them before losses got even worse. Who bought the bonds that these customers sold? The brokerage firms took them off customers hands while providing only wholesale bid prices. Most of the paper landed squarely into those same firms' bond inventories.

Fast forward to the March 8, 2014, issue of Barron’s. After Wall Street firms got the chance to scoop up customer bonds cheaply, it was announced that Puerto Rico had already lined up buyers for $3 billion of new debt. The issue, with an effective yield of about 9%, was oversubscribed by two to three times.

 PR $3 billion bond sale

Bond firms will reap huge underwriting fees moving the new junk-rated paper into public hands while benefiting greatly themselves from the higher prices on their recently acquired inventory of now ‘money good’ older bonds, purchased from scared clients, after the Barron's article and multiple rating agency downgrades. 

 Bailouts of old bonds

The proceeds from the enormous new offering will make payment of old PR debt possible in the same way that overextended consumers sometimes pay off the minimum balance on one credit card by using a cash advance from another credit card.

This week’s new capital raise will give an immediate boost to the value of the old PR bonds. It came too late to help anyone who fretted over the financial headlines and sold already.

Ironically, PR muni owners who never saw the Barron’s story or the rating firms’ downgrade notices are better off than those who kept up with the financial news.

The same principle applied when dealing with stocks from late 2008 right up through the present. Experts convinced people to jettison their holdings at bad prices. Professionals then bought the shares at a discount.

Investors are often worse off for having the proverbial ‘little bit of knowledge’ provided through sound bites from their trusted advisors and the media.

Disclosure: I own no bonds, from Puerto Rico or other issuers.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Whiner's picture

The new crummy PR bonds are senior to old crummy PR bonds which are now subordinated.

Ifigenia's picture

Back to the basics, the principles of economic teach by Nobel Economic Prize winner Peter Bruegel:Large Fish Eat Small Fish

SmittyinLA's picture

Ya we'll see how the "new debt" people compare to "old debt" people war plays out in Detroit soon, does the new debt trump the old debt?   Or NOT? 



SAT 800's picture

Boy that was some story by Bruce Krasting; he really peeled that onion. What a sick scam. All part of the "new normal". Yuck.

pashley1411's picture

The elephant in the room is the lack of a financial regulatory body to preserve the integrity of the markets.  

What we have are financial regulators, and the politicians who enable them, punching their tickets on their way to a lobbyists nameplate.

Financial markets are like much else, like domestic security; Snowden was spot on; spying needs oversight.   What he should also have said is that when every government entity is in on the game, where is the government to oversee the government?   Not going to happen.


kellycriterion's picture

What about buying produce at the supermarket? The careful shopper who buys in season and compares prices gets better quality at much better prices. 1/2 to 1/3 isn't unusual.

Let's keep some perspective. Half the real economy runs on pretty colors, bright shiny objects, and the greater fool theory. Sharps win donkeys lose. People peddling perfect egalitarianism in reality deliver a more terrible and perverse version.

The steep hierarchy of physical and biological systems isn't going to be overturned by modifications of social animals nor should it be. I don't want to go back to the amoeba.

The objective isn't to eliminate corruption and exploitation but to set limits and achieve a balance.

koncaswatch's picture

+1 for your pragmatism. An idealized compass heading through life is OK, maybe even encouraged. However, if I'm confronted with a storm or armada I'll change course until I can come back to original heading.

Frostfan1's picture

How come the sentence "If readers never went to ZeroHedge and bought Gold and Silver in the previous two years, they'd be better off" is nowhere in the article?

kaiserhoff's picture

Worse than Bruce's piece on PR.  Financial analysis is a dying art, for obvious reasons.  Let's cut to the chase.

70 billion plus of outstanding debt, god knows how much in unfunded, off the books, future obligations.  They could not pay the old coupon rate!  None of the authors bothers to say what it is ~ 5%?

So now they will pay 10-12% on an ever increasing debt?  How?

This is kick the can on steroids.

swmnguy's picture

This is a good little illustration of why it's complete baloney when people talk about finance as if it responds to natural laws like gravity.  "If the FED prints money for TARP, it will result in Weimar-style hyperinflation!"  Well, no it won't, because all the fake money is used to buy up fake bonds and never spills out into the real economy.  There are too many examples to list.  I used to say that the street drug market was the only market available to most people that actually responded to supply and demand pressures, but with Colorado and Washington State, now the government is in those markets too.

The merger of State and corporate power (also called "Fascism") always, always, always turns into insider looting and fraud.  That's the whole point.

stormsailor's picture

so your point is that brains, intelligence, dilligence and hard work are punished in our society.Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, ‘Account overdrawn.’ayn rand

FieldingMellish's picture

Any improvement in PR bonds will be temporary. Their situation, like many others, is terminal.

andrewp111's picture

The power to print is infinite. The market can be manipulated for a long time until energy limitations crash the system.

TrustWho's picture

This article documents the pure EVIL of Wall Street and the fascist crony capitalism that governs America. To think Obama was going to fundamentally transform this this aspect of government was STUPID. Obama wanted to give LGBT community their right to get married. Yes, Americans are just plain STUPID. 

Comte d'herblay's picture

Good except for one point.  Somehow, the system known as Capitalism, has gotten a very bad rap being subject to modifiers, like, "crony".

Capitalim does not deserve to be treated so poorly.  It's a great system when it's permitted to exist.

You can not call a system in any way  "_______________ Capitalism" that is a modified form of Socialism. 

By capturing all profits, disposing of all losses by getting the governments to securitize them and then load them on to the backs of billions of people, and/or printing new money to cover the losses and then compounding that outright fraud by placing no restictions on them, allowing the "private" institutions' executives to pay themselves from that money exorbitant bonuses when they should rightfully be living under a cardboard box, in the dark, cold and hungry, dehydrated, and suffering from needle wounds that won't stop bleeding is not in any way, shape or form, any kind of captialism.

A new word needs coined to illustrate clearly this sanctioned crime occurring on a global basis with few countries jailing their bankers. 

But it is no kind of Capitalism. Crony or otherwise. 

PT's picture

Dear C d'h

If you don't like this government then buy your own government.


TrustWho's picture

I agree with you; however, how do you communicate with the stupid American public who have never heard of even Milton Friedman? I think Fascism is best describes the USA system today, but I think Fascism falls short, because the system today is descibed well in the article above and is growing with the central power of our federal government. AND VERY FEW KNOW AND EVEN FEWER CARE.

Comte d'herblay's picture

The only way average human beans will be able to devote the time required to learn all they need to in this complex maze of a system with so many intentional faults built in, is to spend hours every day immersed in what amounts to the same time a serious student enters and graduates from a university with decent grades.

The powers that be know this.  Therefore, they know that their publicists can wait out the news cycle and by the end of it, all is nearly forgotten by enough of the people, and then on to the next Justin Bieber stupid pet trick.

My associates have neither the time nor the inclination to take a few hours each day and even so much as vent on a blog such as this, their frustration, anger, and disappointment at the way things are heading.  If one tries to bring anything serious or something as important----a name, like, Joe Cassano, into a conversation everyone looks at you like you're nuts, Who in the hell is Joe Cassano, and why should they care??

Mention Dick Fuld and most stare at you like you are talking in Klingon. Try telling anyone that Hank Paulson was a crook of the first order and most will think you are talking about some obscure Jewish mafia figure that they've never heard of.  Tim Geithner is already forgotten, and Peter Orszag is some hot news babe's husband. 



LawsofPhysics's picture

Precisely.  When you decide the rules of the game, you can never lose.  Jusk ask all the TBTF banks/bankers.

Let me be clear, roll the motherfucking guillotines, nothing changes otherwise.

TrustWho's picture

Law.....You really believe the urban people of America today have the ability and spirit to execute a French-like Revolution in any USA city? The best I can see is a "Whiner Revolution" with everyone in the streets crying for MAMA.

PT's picture

The good news is that the whiners have no self - discipline and cannot handle hunger.  The bad news is that TPTB live thousands of miles away and the whiners have no idea who they are.

Duc1's picture

Good one.  Each day I hear about highschool and college coaches getting canned because they hurt the fellings of the players.  We are going to have a hard crash.  Half the population will not make it.

TrustWho's picture

Law.....You really believe the urban people of America today have the ability and spirit to execute a French-like Revolution in any USA city? The best I can see is a "Whiner Revolution" with everyone in the streets crying for MAMA.

LawsofPhysics's picture

No, not yet.  As I have said many times, and history confirms, once the supply lines break, everything changes.

Comte d'herblay's picture

Without a major intervention from an unrelated-to-government entity, such as a Tsn......tusnam....soonam....typhoon hitting the shores of either Californica, the Gulf Coast, You Nork, and Jew Nersey, ALL at the same time, the supply lines are good for the next hundred years.

Twinkies alone last for centuries. 

Nothing changes, but at the margins in our lifetime.  The 10% are avaricious, rapacious, elitists who believe they are very very lucky and anointed by the gods; they are murderers and executioners; they are entitled; and they are spoiled rotten, highly financially secure with floating Yacht cities being built to take them away from the scenes to come of war, privation, and blood in the city streets.

But they aren't stupid enough to let it happen till they are well away from it all, and that will take a half century or more.


Cap Matifou's picture

Better you keep away from any promise-on-paper type wealth (destruction) instrument.

LMAOLORI's picture




The Obama Administration's Backdoor Bailout Of Puerto Rico



"The only ones on the short end of the stick are U.S. taxpayers, who are footing the bill that they would probably be unwilling to pay if they were ever asked."


'Backdoor bailout' boosts Puerto Rico's revenues