Ryan Puerto Rico ‘Rescue’ Bill Could Be Windfall for Hedge Funds

The Puerto Rican flag flies near the Capitol building as the island's residents deal with the government's $72 billion debt on July 1, 2015 in San Juan, Puerto Rico.
Joe Raedle/Getty Images

House Speaker Paul Ryan is pressing the House of Representatives to act quickly before its Memorial Day recess on a legislative rescue package for Puerto Rico.

Legislation is expected to be passed through committee on Wednesday and then be rushed through the full House on Thursday, as lawmakers are preparing to leave town for a long holiday weekend and recess.

On Tuesday afternoon, Speaker Ryan’s office released a compendium of quotes from policy experts and the Washington Post editorial board arguing that the rescue package is not a “bailout” of the indebted island territory. In fact, Ryan’s central focus in selling his rescue plan is convincing observers not to call the bill a “bailout.”

In a very narrow sense of the word, the rescue bill isn’t a “bailout.” There is no large check from the US Treasury going to Puerto Rico to help pay off creditors. The legislation, however, would save some individuals and entities from bearing the full costs of past decisions. Moreover, whatever one calls the special legislation being rushed through Congress, it will provide a quick windfall for many, currently unknown, hedge funds.

While precise details of Ryan’s rescue plan aren’t finalized, the legislation is expected to create a financial control board to oversee a restructuring of the territory’s massive $70 billion debt. Aside from rampant government spending in Puerto Rico, the island is suffering from decades of economic micromanagement from Washington. It is unclear whether the control board would have the necessary powers to reform the territory’s economy.

Many supporters of Ryan’s effort point out that bondholders will have to absorb a “haircut” in any restructuring deal. Under some proposals, bondholders would have to accept a 47 percent cut on the par-value of their bonds. For example, if an investor holds bonds with a face-value of $10,000, it would have to accept $5,300 for them in a restructuring.

Supporters stress this as both a means to explain opposition of some bondholders to a federal rescue package and an assurance to outsiders that “Wall Street” will take some losses in a restructuring deal.

This argument, however, obscures the fact that many hedge funds have already purchased Puerto Rico bonds at a steep discount to their face value. On just Tuesday, a host of Puerto Rico bonds were sold at prices ranging from as low as 50 percent below their face-value. These bondholders could realize an immediate gain even after a restructuring enforced haircut, because they were purchased before the new Congressionally-mandated price.

At the end of April, a large block of Puerto Rico bonds were purchased at prices 77 percent below far-value. In other words, an unknown hedge fund purchased bonds at 23.5 cents on the dollar which, under the Congressionally mandated restructuring, will be honored at 53 cents on the dollar. That translates to a 126 percent gain.

“An investor like this who wants to cash in, absolutely wants the federal government involved in a bailout,” Paul Nehlen, who is challenging House Speaker Paul Ryan in a primary, told Breitbart News. “That’s their backstop—their way of ensuring that, no matter what happens or how many other people lose on this mess, they win big.”

While this particular windfall is probably extreme, it highlights the danger of Congress injecting itself into the financial markets. For years, Puerto Rican debt has carried a risk premium, due to fears over the island’s growing debt burden. The island has had to pay higher interest rates than even other US Territories because of the potential default risk. Almost all the credit-rating agencies have downgraded Puerto Rican debt to junk status.

Investors continued to lend more money to Puerto Rico partly because the risk guaranteed them higher interest payments. In addition, Puerto Rico bonds are “triple-tax-exempt,” meaning income from them is exempt from federal, state and local taxes.

These investors lent Puerto Rico money, or purchased the bonds in the secondary market, with both eyes open. For years, these bond mutual funds and hedge funds benefited from very high interest income and special tax treatment in exchange for the risk they assumed. Assisting these bondholders through Congressional action to protect even part of their investment is unfair to those investors who chose to make safer choices.

In any event, much of this debt is already protected by the Puerto Rican constitution. The territory’s constitution requires the government to pay creditors before it appropriates any other money. The government is legally required to pay creditors, even before it pays its own employees. The government of Puerto Rico, and its Democrat allies in Congress, though, would prefer this priority was reversed.

The Ryan rescue package, then, isn’t really legislation to protect investors or US taxpayers. It is a plan to rescue the island’s left-wing activist government from reaping the harvest of its own choices.

Government jobs make up almost one-third of the total employment on the island. This is around double the US mainland and higher than other US territories. The pension system for retired government employees is only 8.5 percent funded, far below the 68.6 percent median funding of public sector pension systems on the mainland. The island government had a $500 million shortfall in its pension payments in 2014.

Ryan’s work on a rescue for Puerto Rico began with a promise he made to Democrat Leader Nancy Pelosi during negotiations over the omnibus spending bill at the end of 2015. In March, as Ryan’s first self-imposed deadline approached, the government of Puerto Rico passed emergency legislation allowing the island’s governor to unilaterally suspend debt repayments. This action, which is likely unconstitutional, was designed to force Ryan to speed approval of a rescue package.

Some conservatives have argued that a strong financial control board, authorized by Congress, could impose an orderly restructuring process for the island’s massive debt and usher in important fiscal and economic reforms. This is certainly possible.

Achieving that, however, necessitates a discussion and deliberations. Speaker Ryan promised a return to the “regular order” of the House when he assumed the Speaker’s gavel last year. Rushing legislation, negotiated with the Obama Administration in private, through a committee and the full House in less than 24 hours is not “regular order.”

The unmistakable fact that some hedge funds have likely gamed the bond market here to reap a quick windfall from Ryan’s rescue package should give some pause. That Congress is rushing into another legislative “fix” of the financial markets, though, ought to bring this entire package to a full stop.


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