Echoing President Obama's interference in the legal bondholder process of the General Motors bankruptcy, President Trump's comments that Puerto Rico's debt "will be wiped out" yesterday has sparked a bloodbath in PR Muni bonds. Puerto Rico's 8s of 2035 have plunging to a record low 35 cents on the dollar this morning from 44 yesterday, as bondholders fled hitting any bid, worried that Trump would follow through on his warning.
And it's getting worse.
Based on his comment, Trump appears to have had the intention of punishing Wall Streeters - naming Goldman Sachs - on their Puerto Rico holdings
“We are going to work something out. We have to look at their whole debt structure,” Trump said during an interview on Fox News Tuesday. “You know they owe a lot of money to your friends on Wall Street. We’re gonna have to wipe that out. That’s gonna have to be - you know, you can say goodbye to that. I don’t know if it’s Goldman Sachs but whoever it is, you can wave good-bye to that.”
This was not the first time Trump targeted Wall Street bondholders, and last Monday Trump pointed to Puerto Rico's "massive debt" problems when he tweeted that it owes "billions of dollars" to "Wall Street and the banks, which, sadly, must be dealt with."
There are a few problems with this: for one, it is unclear how much, if any, commonwealth debt Goldman Sachs Group Inc. still holds in its mutual funds. As of July, significant tranches of its debt were held by companies including Aurelius Capital Management LP, Autonomy Capital LP and Franklin Mutual Advisers LLC, according to Bloomberg data.
The other problem is that much of the island's debt is owed - mostly indirectly - by retail investors. As a reminder, Puerto Rico owes $74 billion.
... oh which however over $50 billion is owed to everyday investors, through Pension Funds and other intermediaries. Less than 25% of Puerto Rican debt is held by hedge funds, according to estimates by Cate Long, founder of research firm Puerto Rico Clearinghouse. The rest of the debt is owned by individuals and mutual funds that are held by mom-and-pop investors.
"For the most part, Main Street America owns this debt," Long said.
"It's not as though these are vultures circling around the island."
Investors piled into Puerto Rican bonds over the last decade, enabling the island's unsustainable spending-spree along the way. They kept buying Puerto Rican debt even as the island fell into an 11-year recession that deepened the debt crisis. Puerto Rico's debt had been a major obstacle for the U.S. territory as it fought for statehood. Bondholders had asked Congress and the Trump administration to hold off on granting statehood until Puerto Rico had paid off its debt.
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In an attempt to temper the market's shock after Trump's comment, Office of Management and Budget Director Mick Mulvaney told Bloomberg that "I think what you heard the president say is that Puerto Rico is going to have to figure out a way to solve its debt problem,” adding that “We are not going to bail them out. We are not going to pay off those debts. We are not going to bail out those bond holders."
In addition to the PR bonds, various bond insurers have also been hit this morning, with MBIA dropping 4.4% pre-market. With some Hurricane Maria economic damage ests. reaching $95b, Puerto Rico will likely prioritize rebuilding expenses over debt obligations, CreditSight’s Josh Esterov writes in note according to Bloomberg. If Puerto Rico were to get federal relief - perhaps via line of credit, as requested by governor - repayment of debt from federal government is likely to take seniority over existing debt obligations.
As Bloomberg notes, it is not clear how Puerto Rico’s debt could just be made to disappear outside of bankruptcy court. Still, to “wipe out” $74 billion in municipal debt, billions of which are guaranteed by the island’s constitution, "would shake investor faith in a market long considered one of the safest of havens. Lower rated municipal borrowers would almost certainly see their borrowing costs rise to account for the added risk."
Maybe there are consequences for 'reaching for yield' after all.