Hedge Funds Win, Puerto Ricans Lose
Wall Street scored a major victory this week in its seemingly endless campaign to extract profit from Puerto Rico, as a federal court approved a deal that locks in 40 years of extremely generous government payments on sales tax–backed bonds, the island’s largest pool of debt.
The restructuring plan for what is known as COFINA debt carries grave consequences for the vast majority of Puerto Ricans: Money that could be funding health care, education, and a just recovery from 2017’s hurricanes and a 13-year economic depression will instead pad the pockets of hedge-fund billionaires and their wealthy investors. Additionally, the deal is structured in a way that will deliver huge profits for vulture funds and significant losses for Puerto Rico–based investors, all the while being funded by one of the most regressive forms of tax there is—a sky-high sales tax, which at 11.5 percent is higher than in all 50 states.
This is, in some ways, the nightmare scenario that critics envisioned when Congress passed the 2016 law that created the legal framework for Puerto Rico’s bankruptcy process, known as PROMESA. That law intensified the colonial status of Puerto Rico, giving an unelected, Wall Street–aligned federal oversight board and a New York–based federal judge tremendous control over Puerto Rico’s future. The COFINA plan is the first debt adjustment approved under the bankruptcy-like Title III process of PROMESA; future plans will be needed to restructure several other pools of debt totaling over $50 billion.
Throughout the process, creditor groups clashed over who had the right to sales tax revenue, and even over whether COFINA violated Puerto Rico’s constitutional limits on issuing debt. In June 2018, court-appointed agents for the Commonwealth and COFINA investors struck a tentative deal to divide the revenues. The deal was more generous to bondholders than expected, and COFINA bonds—which had been trading at rock-bottom prices in the wake of Hurricane Maria—rallied on the news. It was eventually formalized by the oversight board, advanced in a vote by various creditor classes, and then sent to federal court for final approval.
The public was excluded from participating in this decision at every stage, underscoring the deeply undemocratic character of the whole process.
The oversight board and Puerto Rico Governor Ricardo Rosselló have praised the deal as a victory, highlighting that bondholders are taking a 32% haircut, from $17.5 to $11.9 billion in debt. But these numbers are misleading: Even though the principal value of COFINA debt has been cut, the deal has been structured over 40 years, and Puerto Rico will be forced to pay a massive amount of interest on it. The total to be paid under the deal will be $32.3 billion, including interest. That bond prices rallied should be evidence enough that Wall Street got a far better deal than it had reason to expect.
The structure of the deal is bad for Puerto Rico in other respects, as well. There are two major classes of COFINA debt. Senior bonds are the most secure since they are the first in line to collect. Then there are the subordinated bonds, which are next in line. Seniors are recovering 93%, while subordinated are recovering only 54%. That means that senior bondholders—mostly hedge funds—are paid out nearly in full, while the subordinated bondholders—disproportionately Puerto Rican citizens—get their payout chopped in half.
Most senior bondholders will earn massive profits on the deal, in fact. Several hedge funds invested heavily in COFINA senior bonds back in 2015, when the credit of Puerto Rico was already downgraded and the prices of the bonds were collapsing.
One was Baupost Group, the Boston-based hedge fund helmed by billionaire Seth Klarman. Baupost entered Puerto Rico’s bond market in a big way, buying more than $900 million in COFINA bonds. It incorporated ten shell companies in Delaware in August 2015 to hold the investments in order to hide its identity, and managed to do so until The Intercept’s David Dayen broke the story of its speculation on Puerto Rico’s debt in 2017. Though we do not know what price Baupost purchased the debt at, senior COFINA bonds were trading at around 55 cents on the dollar at that time. If Baupost paid that price, the 93% recovery will translate into $170 million in profit for its 2015 senior investments alone.
Another alarming case is GoldenTree, the hedge fund which most aggressively took advantage of Hurricane Maria. COFINA subordinated bond prices dropped significantly in the months following Maria, averaging 15 cents on the dollar between October 2017 and April 2018. GoldenTree went on a buying spree, investing heavily in subordinated bonds. Again, we cannot be sure what price they paid for the debt. But if they purchased it at 15 cents on the dollar, and will get paid 54 cents, they will make almost $160 million in profit on post-Maria investments alone.
It is important to highlight that these hedge funds are not only making huge profits for themselves but also for their investors. These include public-sector worker retirement systems, university endowments, and foundations. Baupost, for example, counts among its clients Harvard and Yale, two of the wealthiest higher education institutions in the world, now profiting at the expense of Puerto Ricans.
By contrast, subordinated bondholders include local businesspeople, small investors, credit unions, and retirees who thought investing in local bonds was a safe bet. Credit unions, in particular, were pressured by the government to invest in bonds and are now taking substantial haircuts. While some local bondholders in the business community praised the deal, most will take a significant hit—and as Puerto Ricans, they will be paying the high sales taxes funding the deal.
The COFINA deal is the first debt adjustment plan approved. There are still four public entities to go, including the Commonwealth (the central government) and the Puerto Rico Electric Power Authority (PREPA). The Commonwealth’s plan is crucial because it involves the government’s General Fund, whose budget allocations provide for all public agencies, including essential services like housing, health, education, and security. In other words, bondholders’ payment demands will be in direct conflict with funding for services for the general population. In the case of PREPA, current negotiations have included a proposal to impose a “transition charge” added to clients’ light bills exclusively to pay the beleaguered authority’s debt.
Notwithstanding all these blows to the Puerto Rican people, a small victory was achieved recently when the oversight board and the Unsecured Creditors Committee filed a motion seeking to declare $6 billion in general obligation bonds null and void because they violated the constitutional debt limit. This substantiates the speculation by some watchdogs and activists that part of Puerto Rico’s debt is illegal. It also offers ground for other possible attempts to declare more debt null and void.
The possibility that Puerto Rico will have to go through another bankruptcy process in five years is very real. With a declining economy and an unstoppable wave of emigration, adjustment plans like the COFINA deal are creating the conditions for future defaults. The only upcoming improvement in the economy will be as a consequence of the impact of federal recovery funds, including those from the Federal Emergency Management Agency (FEMA) and the Community Development Block Grant—Disaster Recovery (CDBG-DR). But the effect of these funds will only last for five years, and the oversight board is taking advantage of them to double the money available to pay bondholders, instead of using these resources to improve conditions for Puerto Ricans.
The hedge funds and the oversight board are mortgaging the future of the upcoming generations who don’t have a say in these crucial matters. Now more than ever, the Commonwealth is becoming a playground for Wall Street and millionaire investors at the direct expense of the people. Opposition to these agreements is growing, and with them international solidarity must grow too.
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